How the Federal Reserve affects mortgage rates (Hint: It may not be how you think)

lIf you’re considering buying a home or exploring refinancing options, you’ve probably noticed that mortgage rates seem to have a mind of their own — sometimes moving up when you’d expect them to fall. At its meeting last month, the Federal Open Market Committee (FOMC) voted to hold its benchmark interest rate at 4.25% to 4.5% for the third meeting in a row, maintaining a wait-and-see stance amid mixed economic signals.

But here’s what catches many aspiring homebuyers or those looking to borrow money off guard: The Fed’s interest rate is for overnight lending between banks, while the rates on 30-year mortgages are primarily linked to the 10-year Treasury note. Since Treasury yield rates move based on investors’ expectations about the economy, they can rise even when the Fed cuts its short-term rate. That said, some loans like adjustable-rate mortgages (ARMs) and home equity lines of credit (HELOCs) do follow Fed policy more directly.

With another Federal Reserve policy meeting on the horizon this week, here’s how to understand connections between the Fed rate and borrowing costs to make smarter decisions about when to buy, refinance or take out a mortgage or home equity loan.

⭐️ Other stories in this series

• How the Federal Reserve affects your savings

• How the Federal Reserve affects your student loans

Quick explainer: What is the Federal Reserve?

The Federal Reserve is the nation’s central bank with the stated mission to guide the economy toward twin goals of encouraging job growth in the labor market while keeping inflation under control. The Fed’s rate-setting arm — the Federal Open Market Committee (FOMC) — typically meets eight times a year to either raise, lower or maintain a key benchmark interest rate called the federal funds rate — commonly called the Fed rate.

This dual mandate means the Fed attempts to balance the goals of keeping people employed with the need to prevent prices from rising too rapidly — though some critics suggest the two ideas in its monetary policy clash, saying that efforts to control inflation by raising rates can harm businesses, and by extension, employment rates.

🔍 Learn more: When’s the next Federal Reserve policy meeting? What to expect for your finances

How does the Federal Reserve impact what you pay for a mortgage?

For 30-year fixed-rate mortgages — the most popular type of mortgage loan — lenders determine your rate in two steps. First, mortgage lenders look to the 10-year Treasury note as their baseline benchmark. Then they add a spread on top of that Treasury rate to cover their costs, risks and profit margins.

The spread comprises:

• The primary mortgage spread. This is the difference between what you pay and what banks get when they sell your mortgage as part of a mortgage-backed security (MBS).

• The secondary mortgage spread. The difference between what investors pay for mortgage-backed securities versus safer Treasury bonds. The secondary spread averaged 0.71% from 2012 to 2019 but expanded to 1.4% from January 2022 through November 2024, according to Fannie Mae.

The Fed influences this system indirectly. When the Fed changes short-term rates, it can affect investor expectations about future economic conditions, which moves Treasury yields up or down. But Treasury yields also respond to inflation expectations, economic growth prospects and global economic conditions — factors that can move independently of Fed policy.

🔍 Learn more: 6 ways to get the lowest rate on your next mortgage

How the Fed rate affects adjustable-rate mortgages (ARMs)

The rates on ARMs are typically tied to the Secured Overnight Financing Rate (SOFR) or the prime rate. SOFR reflects the cost of borrowing cash overnight using Treasury securities as collateral. When the Fed raises or lowers rates, it influences the SOFR, which in turn affects ARM rates when they reset every six months after your initial fixed period ends.

This means if you have an adjustable-rate mortgage, you’ll feel the impact of Fed decisions more quickly and directly than those with fixed-rate loans. When the federal funds rate rises, your ARM rate will likely increase at the next adjustment period.

🔍 Learn more: Is your ARM adjusting soon? Here’s how to convert it to a fixed-rate mortgage

How the Fed rate affects home loans and HELOCs

Home equity lines of credit (HELOCs) and some home equity loans have a more direct connection to the Fed policy than other types of loans. That’s because rates on HELOCs are linked to the Wall Street Journal Prime Rate, which is the base rate banks offer their most creditworthy customers. The prime rate, in turn, moves with the federal funds rate.

The prime rate is typically set about 3 percentage points above the federal funds rate and serves as a baseline for many consumer lending products. Since most HELOCs use the prime rate as their foundation, changes in Fed policy translate almost immediately to changes in what you’ll pay on a home equity line of credit.

This direct relationship explains why HELOC rates have risen significantly in recent years. A $30K home equity line of credit (HELOC) increased from around 3.5% in early 2022 to more than 8% percent today, reflecting the Fed’s aggressive rate-hiking campaign to combat inflation.

🔍 Learn more: Home equity loan vs. HELOC: Which is a smarter move for borrowing right now?

What to consider if you’re buying a house or applying for a mortgage

If you’re entering the housing market, understanding Fed policy can help you time decisions somewhat, but it shouldn’t be your only consideration. Here are some important things to think about before buying and getting a mortgage.

Before you start house hunting

• Consider if you’re buying for the long haul. Buying typically makes the most sense when you plan to stay for at least five years or longer. This gives you time to build equity and recoup costs. If you need to sell sooner, you could lose money, especially if home values decline — as they are in more than half of US states right now.

• Be aware of market timing risks. Buying during price declines may offer opportunities for better deals, but means slower equity growth. Buying during rapid price increases means paying premium prices and risking negative equity if the market corrects. In either scenario, you could lose money if forced to sell quickly.

• Build and maintain good credit. A score of 670 or higher can save you thousands over the loan’s life. Even moving from 680 to 740 could shave 0.25% to 0.5% off your rate. Start with our five simple steps to cleaning up your credit.

• Reduce your debt-to-income ratio (DTI). Keeping your DTI under 43% will help you qualify for a mortgage, so try paying down your credit cards, car loans and student loans before applying. The debt snowball and debt avalanche method are two time-tested strategies for reducing debt.

• Save for a larger down payment. While you can buy with just 3% down or less, putting down 10% to 20% shows lenders you’re lower risk, and a 20% down payment eliminates private mortgage insurance, saving you hundreds monthly.

• Research the local market. Look at recent sales, price trends and neighborhood conditions. Understanding whether you’re in a buyer’s or seller’s market can help with timing and negotiations.

During the mortgage process

• Shop around with multiple lenders. This could save you thousands, as mortgage rates can vary between lenders for the same borrower profile. Getting multiple quotes within a short timeframe — typically 45 days — counts as a single credit inquiry, reducing the impact on your credit.

• Compare APRs — not just interest rates. Some lenders advertise low mortgage interest rates but offset them with high fees. The APR factors in origination fees, points and processing fees, giving you a clearer picture of your total borrowing cost.

• Time your application carefully. Avoid major financial changes during the mortgage process — don’t switch jobs, open new credit accounts or make large purchases between application and closing, as new credit or debt might derail your approval.

• Consider different loan programs. Popular first-time homebuyer programs, FHA, VA, or USDA loans might offer better terms for your specific situation.

• Budget for total housing costs. Your monthly payment — including your principal, loan interest, taxes, homeowners insurance and, if applicable, HOA fees — should ideally be no more than 28% of your gross monthly income.

• Get a thorough home inspection and budget for potential repairs. Many homebuyers discover expensive repairs after moving in that weren’t apparent during inspection, especially in older homes that have outdated plumbing and wiring, as well as new builds where corners were cut.

🔍 Learn more: How to shop for a mortgage: A guide for smart homebuyers in 2025

Should you refinance your mortgage after Fed rates drop?

The Fed doesn’t influence mortgage rates directly — rather, mortgage rates follow Treasury yields and investor sentiment in the bond market.

However, the decision to refinance involves more than just comparing your current rate to available rates, and changes in Fed policy don’t automatically translate to lower mortgage rates or high benefits for refinancing.

When refinancing might make sense

• You can reduce your rate by at least 0.5% to 1%. This threshold helps ensure the savings outweigh the costs and hassle of refinancing. For example, dropping from 7% to 6% on a $400,000 mortgage saves about $240 per month (or $2,880 per year), which could justify closing costs of $8,000 to $12,000 over the long term of four years or more.

• You plan to stay in your home long enough to recoup closing costs. Divide closing costs by monthly savings to determine your breakeven point. If refinancing costs $12,000 and saves you $240 monthly, you’d need to stay in the home for over four years to break even.

• Your credit score has improved since your original mortgage. A jump from 680 to 740+ could qualify you for much lower rates regardless of market conditions. At any rate (no pun intended), it doesn’t hurt to shop around for lenders and compare multiple quotes.

• You want to refinance your ARM to a fixed-rate mortgage. Refinancing your adjustable-rate mortgage can provide payment stability, especially if you’re facing a rate increase at the end of your ARM’s fixed period. Even if rates are similar, locking in predictable payments might provide greater peace of mind.

• You need to tap into home equity for major expenses. A cash-out refinance might make sense for home improvements or debt consolidation, but only if you can reduce your rate at the same time and plan to stay in your home long enough to recoup refinancing costs.

Potential drawbacks to consider

• Closing costs can range from 2% to 5% of your loan amount. On a $400,000 loan, expect $8,000 to $20,000 in fees including appraisal, title insurance, origination fees and other charges. These upfront costs can take years to recoup through lower monthly payments.

• Extending your loan term might increase total interest paid over time. Moving from 25 years remaining on your current loan to a new 30-year mortgage means lower monthly payments, but potentially tens of thousands more in total interest. You’re essentially trading short-term cash flow for long-term costs.

• You’ll restart the clock on building equity if you take out cash. Unlike home equity loans, a cash-out refinance reduces the equity you’ve built and increases your loan balance, meaning you start over on the path to owning your home outright. You’re also converting an appreciating asset back into debt.

• Your current rate might already be competitive despite recent changes. If you locked in a rate during the historically low period from 2020 to 2021, today’s rates may not offer meaningful savings. A 3% mortgage from 2021 likely beats anything available today, making refinancing counterproductive regardless of recent market shifts.

💡 Key takeaways: Refinancing decisions should be based on your individual financial situation and long-term housing plans, and not only short-term interest rate movements. For example, even with the slight dip in mortgage rates following Pres. Trump’s April 2 tariff announcement, mortgage rates have risen again amid continued economic uncertainty.

Learn more: When to refinance your mortgage: 4 key times when refinancing can make sense

Other stories in our mortgages and home loans series

• 4 ways to get equity out of your home while rates are high

• Do you qualify for homebuyer assistance? You might — even if you’ve already owned a home

• How much does a 1% rate change matter to your mortgage?

• Cash-out refinance vs. home equity loans: Which is best in today’s market?

• Fact vs. fiction: Top 7 most common home equity myths

FAQs: Mortgage rates, the Federal Reserve and your money

Learn more about mortgage rates with these commonly asked questions. And take a look at our growing library of personal finance guides that can help you earn money, save money and grow your wealth.

Will my mortgage rate go down if the Fed cuts rates?

It depends on your type of mortgage. If you have a fixed mortgage rate, your rate will remain the same regardless of Fed actions. However, if you have an adjustable-rate mortgage (ARM) or a home equity line of credit (HELOC), your rate may decrease after a Fed rate cut, though the change may not occur immediately — it typically happens at your next rate adjustment period.

I own a home. Can I use my home equity to downsize for retirement?

Yes. If selling isn’t the right move yet, you could look into a HELOC or home equity loan to access cash while keeping ownership of your home. Or if you’re age 62 or older and want to supplement your retirement income without monthly loan payments, a reverse mortgage is an option — just make sure you understand the risks. Weigh the benefits and drawbacks with our guide to using home equity to downsize.

How quickly do mortgage rates respond to Fed decisions?

The response varies by loan type. Fixed-rate mortgages may not respond immediately or proportionally because they’re primarily influenced by the 10-year Treasury yield rather than the Fed funds rate. ARM and HELOC rates typically adjust within a month or two after a Fed rate change.

Why don’t mortgage rates always move in the same direction as Fed rates?

Mortgage rates are primarily influenced by the yield on 10-year Treasuries and investor demand for mortgage-backed securities as well as other factors like economic growth expectations and market volatility — all factors that can move independently of Fed policy.

Sources

• Average Mortgage Rates by Credit Score, Experian. Accessed June 16, 2025.

• What Determines the Rate on a 30-Year Mortgage?, Fannie Mae. Accessed June 16, 2025.

• Current home equity rates, Bankrate. Accessed June 16, 2025.

About the writer

Kat Aoki is a finance writer who’s written thousands of articles to empower people to better understand technology, fintech, banking, lending and investments. Her expertise has been featured on sites like Lifewire and Finder, with bylines at top technology brands in the U.S. and Australia. Kat strives to help consumers and business owners make informed decisions and choose the right financial products for their needs.

Article edited by Kelly Suzan Waggoner

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