The mortgage interest rate is the rate borrowers are most concerned about because it determines your monthly mortgage payment and what you can afford. Everyone wants the lowest possible interest rate so that their monthly payments will be lower, and you can pay your home off quicker.
This rate is determined by the lender, considering various factors such as income, credit score, and employment stability. However, the first factor they consider is the Federal Funds Rate.
So, what exactly is the Federal Funds Rate?
The Federal Funds Rate, as reported by U.S. News, is an interest rate established by the Federal Open Market Committee (FOMC). The FOMC meets 8 times a year to determine if they will raise, lower, or keep the Fed Rate the same. When you hear the news or market forecasters discussing the interest rate “set by the Fed”, they are talking about the FOMC.
Banks charge this rate to other banks when they lend each other money, usually overnight or for a few days. Basically, a short-term interest rate. There’s a lot that goes into their decision-making process but that’s for another day and another blog. Let’s just focus on how we get to mortgage rates.
Think of the Federal Funds Rate as the baseline or start-off point.
For Example, the current Fed Rate today is 5.25%-5.5% per Nerdwallet.com. You go to your bank and ask for a loan. They will not give you a loan any lower than the start-off point at the Fed rate of 5.25% because the bank itself pays that rate when they borrow money. They have no choice but to charge you higher than what they are getting charged in order to make a profit.
Now, your individual financial situation comes into play. Your bank evaluates factors such as income, credit score, and employment history to determine the additional percentage they will charge you above the Fed rate. The stronger your financial standing, the better your rate.
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