Why Waiting On The Fed For A Better Mortgage Rate May Not Make Sense

If you’ve been paying close attention to financial and mortgage markets in preparation for buying or refinancing a home, you’ll likely have heard about the influence the Federal Reserve (Fed) has on mortgage rates through its setting of the target range for the federal funds rate.

The impact of Fed policy is real, but the market doesn’t always move at the same time the Fed does. In fact, the markets try to stay ahead of officials as a general rule. We’ll talk about why and we’ll touch on the implications for those currently in the market for a mortgage.

Understanding The Secondary Mortgage Market

To understand why the Federal Reserve decision may not have the impact that one would expect – rates go up or down immediately – it helps to understand a little bit about the secondary mortgage market. While this won’t be enough information to make you a junior bond trader, it should give you the insight to make the right mortgage move.

In the past, when you closed on your mortgage, lenders would hold on to your loan over the course of the term, making the money back a little at a time until the loan was fully paid off. That doesn’t happen much anymore because it limits the number of loans a lender can make if they have to wait up to 30 years to get the money back.

The secondary market allows lenders to sell loans, usually to one of several major investors. This allows lenders to get revenue on a much quicker basis so that they can make more loans. The system facilitates the liquidity that underlies the mortgage market in this country and helps with affordability.

Just because your loan is sold to an investor doesn’t mean that your relationship with your mortgage lender has to end. Your lender may service your loan, meaning they forward your payment to investors and maintain your escrow account. Most of the time, Rocket Mortgage^® keeps servicing your loan.

While mortgage loans are typically sold, there’s often a delay between the time the loan closes and when it’s sold to the mortgage investor. The interval may be 60 days or more. Moreover, your lock you rate even earlier in the process, often before any appraisal or underwriting checks take place.

Based on mortgages being sold a couple of months after you close, the rate that you receive whenever you choose to lock is priced based on what the lender feels the rate will be then as opposed to what it is today. Because of this, everyone in the market really tries to anticipate what the Fed is going to do well before they do it.

What Mortgage Market Participants Are Looking For

Investors are constantly trying to stay ahead of the Fed, but no one has yet been able to invent a time machine for perfect future prediction. So what indicators are they looking at?

What The Fed Says

While the actual decision day may not move the market, the Federal Open Market Committee (FOMC) releases a press release after every rate decision outlining not only what the federal funds rate will be until the next meeting, but some of its thinking in terms of the state of the economy and where things might be headed in the future.

The FOMC meets eight times a year. Investors scrutinize every word of the statement and try to hear the hidden meaning in every word of Federal Reserve Chair Jerome Powell’s press conference.

A couple of weeks after each meeting, the Fed releases the minutes. This gives market participants the opportunity to be somewhat of a fly on the wall and get inside the heads of the committee members.

Additionally, once per quarter, the Fed releases its projections for the economy, and importantly, where it see rates sitting in the future. This doesn’t mean the Fed will never change its mind based on further data, but it is important knowing exactly what participants think because they’re in control of the target range for the Fed rate.

Based on where the committee thinks rates will be in the future, market participants can start pricing in where they think rates will be at various points. For instance, if the Fed projected that by next year, the federal funds rate would be 1% higher or lower than its current level, they might anticipate two to four rate changes over the coming year.

If officials think they need to move a little faster or slower, that determines whether they move 0.25% – 0.5% at a time. The only time they make adjustments bigger than that is when they consider something more of an emergency situation.

Just as importantly, the market can typically predict when rate movements are going to happen because the meetings are scheduled. Unscheduled changes are rare. The last time this happened was when COVID-19 hit the U.S. Before that, it was the 2007 – 2008 financial crisis. So the rate movements can be priced into bonds backing mortgages.

The reality is that the Fed does so much more communication than they have in prior decades that investors are almost never surprised when the Fed announcement comes out.

Following The Data

No matter what’s been anticipated by the Fed in talks and official predictions, economic data plays a big role in whether the Fed is likely to raise or lower rates. The Fed only makes moves at meetings, but the market changes its opinions daily, and sometimes multiple times per day, based on the incoming data.

The markets are particularly interested in economic reports that relate to the Fed’s two-sided mandate. The Fed is charged with setting the conditions for both maximum employment and stable prices. Those two goals are often at odds with each other. The market is constantly trying to figure out which way the balance of the scale is leaning.

In recent years, inflation has risen quite a bit, largely due to supply chain issues and stimulus related to the pandemic. As a result, the Fed has been focused on getting inflation back down to its goal of around 2% per year. That’s enough to encourage spending while maintaining the worth of your money.

The inflation problem has caused officials to raise rates consistently in the last several years. This discourages borrowing, which tends to bring inflation down because people have less to spend.

Now inflation is coming down, but the flip side is that jobless claims and the unemployment rate have started to come up. Businesses begin to lay people off if there’s not as much spending on goods and services. Things have started to tip back to a greater concern about the labor force, which tends to push rates down.

On the inflation side, investors look at the consumer price index and personal consumption expenditures index, the latter being the Fed’s preferred measure for inflation. They also consider expectations for inflation. If consumers expect prices to go up, they tend to rise as you’ll pay more thinking the price could be higher tomorrow.

On the labor end of the equation, traders look at data like jobless claims, job openings and labor turnover (JOLTS), business sentiment and monthly employment reports.

While these are some of the main data points used, there are other indicators of rising or falling mortgage rates. Mortgage rates tend to closely track the 10-year treasury yield, so as that goes rates go.

Traders may also look at the spread between the 2-year and 10-year treasury yields. In a normal environment, the yield would be higher on the longer-term treasury because you’re tying up your money longer.

In the past, the 2-year yield moving higher than the 10-year yield has been an indicator of recession because it means people feel like a long-term investment is safer than the short-term one. This is referred to as an inverted yield curve. In a recessionary environment, the Fed tends to lower rates to kickstart the economy.

The market essentially tries to use these data points to play the game right along with the Fed and predict what happens next.

What This Means If You’re In The Market For A Mortgage

Rates move up and down frequently as traders react to current economic conditions. But as someone who is just looking to buy a home, lower your rate or take advantage of your existing equity, what are the key takeaways?

Don’t Try To Time The Market

It’s difficult enough to try to figure out when you should make a move and lock your mortgage rate, but if you’re keying off the Federal Reserve rate decision, that may not work for you because it’s been priced in.

You should focus on the payment and lock the rate you currently see if you like it rather than focusing on whether you might be able to get a lower rate tomorrow. Rates could just as easily be higher. Focus on the amount you can afford every month as well as whether you’re ready personally and financially to move forward.

Prepare Before Applying

The other thing you can do to get ready to move forward is to make yourself the most attractive client possible to lenders. All lending is based on risk profiles. The more you can make yourself look like a good risk, the better your rate is going to be. Lots of factors help determine your rate, but there are several things you have influence over.

• Get your credit ready. Your credit helps determine the interest rate you receive because it’s a snapshot of your past to help predict your risk in the future. Make sure you check your credit report and dispute anything that looks wrong. Focus on making on-time payments and using less than 30% of your overall credit card balance. You also don’t want to apply for any new credit while trying to get a mortgage because it’s a sign you could be overextending yourself and will temporarily drop your score.
• Save for a down payment. Ultimately, the timing for giving your mortgage will depend on when you’re personally ready and there are several low down payment options. At the same time, if you can save for a bigger down payment, that often means a better interest rate because you’re not borrowing as much. When you refinance, the interest rate is based in part on the amount of equity you’ll leave in the home after you refinance.
• Work on paying off debt. While not rate-related, this impacts your qualification. If you’re trying to apply for loans, you want to work on paying off existing debt as it impacts the monthly payment you can afford. In qualifying you for a monthly payment, lenders look at debt-to-income ratio (DTI). The lower your debt is going into the transaction, the more flexibility you may have to qualify for a higher payment.

The Bottom Line

Mortgages are sold a couple of months after you close and you lock your rate before that. Given this, the market prices in what it thinks the Federal Reserve will do with interest rates well before any movement either way actually happens. Rather than waiting on the Fed, lock the rate and payment when you see one you like.

If you’re ready to buy a home or refinance, start an application today.