What is the Federal Reserve?
The Federal Reserve is not federal and it is not a reserve. The Federal Reserve System is the central bank of the United States. The primary functions of the Federal Reserve are to create and maintain monetary policies, supervision, regulation and financial services.
When Congress created the Federal Reserve Act in 1913, it was about protection, security, and preventing the panic seen in 1907. The act delegated a system of independent banks responsible for managing the country’s currency called the central bank. The act also gave rise to the IRS, the Federal Reserve System, and income tax. This piece of legislation changed the financial system of the entire world.
The Fed, as the Federal Reserve is informally called, influences the economy through financial actions called policy levers. Among the most important levers of monetary policy is setting the federal funds rate, which has derivative effects on mortgage rates. The federal funds rate is the interest rate at which banks and credit unions lend money to one another.
What does the Fed have to do with the real estate market?
When the economy needs first aid, the Federal Reserve can step in and help by cutting rates. It was the Fed that cut rates to historic lows in 2008 in part, to reboot the collapsed housing market. By December of 2008 the Federal Funds Rate was near zero, and this was the beginning of a recession.
Theoretically, lower rates encourage spending and increase demand. When it is cheaper to borrow money, motivation to save decreases, and there is more disposable money to spend. Then once the economy improves, the Fed raises rates as a way of prevention for any future hard times.
Anticipation and speculation over if and when the Fed will indeed start to raise interest rates has been going on for months now.
Janet Yellen, chair of the Board of Governors of the Federal Reserve System, has made repeated statements about the improving health of the U.S. economy. Back in July, Yellen said, “Based on my outlook, I expect that it will be appropriate at some point later this year to raise the federal funds rate and thus begin normalizing monetary policy.” And this week, Yellen said an interest rate hike next month is a “live possibility” if the economy stays on track. That being said, there is still no firm decision on whether or not the rates will be changed.
If the Fed increases interest rates, then mortgage rates, among others, will also increase. Many theorize that the big rush of mortgage applications in 2015 was in response to these murmurings. Refinancing is a way to lock in to the lower rates before they increase. However, many housing experts agree that a slight raise by the Fed will not have a significant impact on mortgage rates.
The Fed will meet again on Dec. 15 and 16 and many will be anxiously awaiting their decision on interest rates. The media will continue to give this a lot of attention and part of what fuels our behaviors in relation to the Fed’s rate are the constant references. The sensational headlines have a tendency to engender exaggerated reactions.
Keep in mind that there is not as strong a correlation between the Fed’s rates and mortgage loan rates as most consumers have been led to believe. Lenders say that it takes a full percentage point increase to have any noticeable effects. For example, a quarter of a point interest rate increase on a $500,000 mortgage only shows an increase of $70 a month. The Fed’s historical trend is to raise rates by a quarter of a point.