The Driving Factors behind Mortgage Interest Rates

If you’ve spent any time at all watching the news or reading the newspaper recently, there’s a good chance that you’ve read at least one article about how mortgage interest rates are expected to climb throughout 2022. Interest rates climb and fall for many different reasons, and you can learn more about some of the major ones below. 

The Federal Reserve 

The Federal Reserve (sometimes simply called the “central bank) influences national mortgage rates quite a bit. It is the central bank of the United States and one of the most powerful financial institutions in the world. It’s important to note that while the Federal Reserve’s banking decisions absolutely do affect interest rates associated with savings accounts and CDs, the institution does not set mortgage rates. Rather, housing and mortgage market analysts interpret the Federal Reserve’s intentions to raise or lower interest rates, and individual lending institutions use those interpretations to set interest rates for their products – including mortgages. 

In January 2022, the Federal Reserve announced that it would increase its interest rate for the first time since 2018, but rather than increasing it all at once, the central bank said it would instead issue six incremental increases. The first of these increases came at the end of the Federal Reserve’s March 2022 meeting; the rates were raised by a quarter of one point. Five more similar increases are planned before the end of 2022, and the rates are expected to be 4.5% by the end of those increases. 

The State of the Economy 

The Federal Reserve plays an important role in the decisions financial institutions make about their mortgage rates, and underneath it all, it’s the state of the economy – both in the US and around the world – that drives the Federal Reserve’s decisions. The central bank utilizes a variety of economic growth indicators, which include the current employment rate and the current and predicted Gross Domestic Product (GDP), to determine the interest rates. When the economic growth is high, rates tend to rise. When that growth stalls, the interest rates tend to fall. 

These factors influence interest rates because of the limited amount of capital available that is available for lending. To put this into perspective, in a slow economy where unemployment is high and wages are low, fewer people are interested in home loans. As such, the lenders are pressured to make their loans more attractive and attainable by offering lower interest rates. Conversely, when the economy is strong – meaning wages are good and unemployment is low – the demand for home loans grows sharply, and lenders increase their interest rates because they simply do not have the capital to meet the needs of every single aspiring borrower. 

In a nutshell, the state of the economy drives the Federal Reserve to make important decisions about its banking practices. A growing economy means higher interest rates while a stagnant economy leads to lower interest rates, and lenders consider all of these factors when determining their own interest rates on mortgages. Ultimately, like anything else, mortgage rates are directly affected by supply and demand.