Getting to the heart of a complicated financial matter in a few paragraphs is no easy feat, but we’ll try. After all, interest rates are an important variable in housing and lending.  It’s a good idea to understand how the Federal exerts its influence on our lending rates.

The Fed has been a central and pivotal figure since the 2008 financial crisis. It has moved to lower interest rates to levels rarely seen.

The usual way to lower rates is to simply move the range on the federal funds rate – a key overnight lending rate for commercial banks. The Fed influences the fed funds rate by adjusting the interest rate it pays banks on the reserves banks hold at the Fed.

Today, the Fed pays 50 basis points on these reserves, which was raised from 25 basis points in December. The fed funds rate, in turn, adjusts to reflect the rate the Fed pays on bank reserves.  No bank will lend for less than the Fed pays on reserves, so the fed funds rate adjusts to what the Fed pays on bank reserves.  Other lending rates adjust to the fed funds rate over time.

Buying and selling securities are other means to influence interest rates.

When the Fed buys a mortgage-backed security or a Treasury security, it pays with newly created money.  The Fed buys these securities from banks and primary dealers. The money is credited to the seller’s account at the Fed. This creates liquidity – more money to lend.  At the same time, the Fed’s demand for these securities raises their price and lowers their yield. Interest rates tend to fall.  The opposite occurs when the Fed sells securities; rates rise. Other interest rates take their lead from what is paid on these low-risk securities.

Mortgage rates tend to take their immediate lead from long-term Treasury securities, particularly the 10-year U.S. Treasury note.  The 30-year fixed-rate mortgage is typically quoted around two percentage points higher than the yield on the 10-year note. This is why we frequently refer to trends in the yield on the 10-year note to get an idea of where mortgage rates are heading.

So, if you want to get an idea of where mortgage rates are heading, keep an eye on the 10-year U.S. Treasury note yield (found readily at Yahoo Finance) and the effective federal funds rate (found at Bloomberg). Both will give you an idea of what to anticipate in our lending market.

Information provided by Jessica Regan.

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