The question I get asked most often, whether I’m having a beer or sitting at an open house, is “do you think they’re going to raise rates anytime soon?” Of course most of them are talking about mortgage interest rates, trying to predict the future and get the best possible rate for their loan. But, I also wonder if it’s such a topic of interest because of confusion between the federal interest rate heard in the news and the mortgage rates you and I borrow money on? I’m here today to clear up the confusion, and explain the difference between the two.
Banks are businesses. You deposit money into a bank, they hold it for you, say “thank you” by giving you a small interest rate on it, then use it to pay their employees with it and loan it out to other people. Some banks are bigger with more clients and more money, and some banks are smaller with customers and less money. Regardless of size though, all banks need cash to loan out for mortgages, small business loans, and other products in order to charge interest and bring in income. So, how does a smaller bank compete with a bigger bank and be able to offer loans? They borrow money from each other at an interest rate, just like any other loan product. However, unlike your mortgage on your house, this loan rate is dictated by the federal government and called the “federal funds rate.”
For example, say I walk into “Bank of Manoa” and ask for a mortgage. Since Bank of Manoa is a smaller bank, they need to borrow money from a larger bank (Bank of Hawaii), who has a lot of cash on hand to loan out. At our current federal funds rate of 0%, Bank of Manoa gets to borrow that money from Bank of Hawaii for no-interest, and is able to fulfill my loan!
However, if the federal reserve decides to change that federal funds rate, then that affects how costly it is for banks to exchange funds. The higher the fed requires, the higher the cost, which could translate down to a higher mortgage rate on your loan. Of course, there are many factors that eventually go into your actual mortgage rate besides the fed, but it is one determining factor.
For more information on the fed rate and how it affects your loan, talk to your favorite loan specialist or ask me for recommendations!