What does it mean when the Fed cuts interest rates?
Quick insights
- The Federal Reserve (also known as “the Fed”) periodically adjusts the federal funds rate to stimulate or steady economic activity, which also impacts the housing market.
- When the Fed decides to cut the federal funds rate, interest rates for mortgages generally go down, alongside broad reductions in banks’ lending rates.
- While a rate cut can mean better rates to buy or refinance a home, the increased demand can result in higher listing prices for homes entering the market.
If you’re preparing to buy a home, it can be helpful to read news from the Federal Reserve to understand current interest rates on mortgages. The Fed periodically updates the federal funds rate, which is the rate applied to bank activities as they lend money to one another overnight. When the Fed cuts or raises this rate, the effects on the economy can be significant, including interest rates for homebuyers.
In this article, we’ll provide further insight into the Fed and what happens when the fed cuts interest rates. We’ll also discuss potential outcomes and considerations for homebuyers and homeowners.
The Fed’s role in everyday economics
The Federal Reserve is the U.S. central bank, created by the Federal Reserve Act of 1913 to establish a monetary system that could effectively respond to stresses in the banking system. Although operationally independent, the Fed has two goals mandated by Congress:
- To promote maximum employment
- To promote stable prices for goods and services
The Fed also plays a role in fostering safety and efficiency for U.S. payment systems, including (but not limited to) distributing currency and coins, acting as the government’s bank and providing information regarding broad economic conditions.
Factors influencing the federal funds rate
One of the most discussed activities of the Fed is the raising or lowering of the federal funds rate. The Federal Open Market Committee (FOMC) meets periodically to discuss macroeconomic conditions, including inflation, employment rates and economic growth. The FOMC then determines if the Federal Funds Rate should change.
Rate change announcements are typically accompanied by a detailed explanation of the update. Though the Fed is an independent organization, it may be called on to defend its rate changes to Congress.
Increasing the federal funds rate
Increasing the federal funds rate raises costs for financial institutions, which may raise rates they offer consumers to borrow money. Increasing the federal funds rate is thought to help steady economic activity in times of volatility. Raising the federal funds rate is sometimes used as a tool to lower inflation.
Decreasing (or “cutting”) the federal funds rate
Decreasing the federal funds rate can lower costs for banks, which can result in lower borrowing costs for consumers. Rate cuts are thought to help stimulate the economy during an economic downturn. However, if the economy surges and supply cannot keep up with demand, there may be increased inflation in the cost of goods.
What does cutting interest rates do for homebuyers and owners?
The impact on mortgage interest rates after a rate change can be significant for buyers and owners alike. When the fed cuts interest rates, it’s seen as a signal by some that it’s a good time to buy or refinance a home. Some may even base their entire decision off this timing—for example, buying when the rate is cut, or holding off if it rises.
Homeowners with adjustable-rate mortgages (ARMs)
Homeowners with an ARM may benefit from monitoring rate changes throughout the course of their loan. With an ARM, the interest rate on your loan fluctuates in accordance with the federal funds rate. Keeping an eye on this rate can help homeowners with an ARM prepare for changes in their monthly payments. This loan type may be beneficial when rates are high by allowing homebuyers to benefit from future rate drops without refinancing.
Possible negative impacts of rate cuts for buyers
While some buyers might jump at a rate cut, it’s important to recognize the potential downsides. As mentioned previously, rate cuts also have the potential to increase inflation, with effects that can be seen from the supermarket to the housing market. You may find that although interest rates decrease after a cut, the listing prices for homes may go up. When examining real estate comps, limiting your search to homes sold after the most recent rate change may give the most accurate picture of the current market.
In conclusion
Is cutting interest rates good or bad for the real estate market? It depends on how you think about it. For those who are single-mindedly focused on interest rates, a rate cut from the Fed could be a big plus. However, these moves are not without certain challenges. No matter how you slice it, monitoring news from the Fed can be helpful for those buying a home or with a current mortgage.
For specific questions about getting a mortgage, consider opening a dialogue with a Chase Home Lending Advisor.
