How Are Mortgage Rates Set?

When you're considering a mortgage loan, a primary factor in your decision is the mortgage rate that you'll pay. If you're opting for an adjustable-rate mortgage, you'll want to be sure that you can meet your commitment, even if interest rates rise. That's why it's important to understand how mortgage rates are determined.

When people talk about America's monetary policy, they're referring to the actions taken by the Federal Reserve Bank that affect the availability and cost of money and credit. The Federal Reserve's job is to keep the economy on an even keel. To accomplish this, it works through subdivisions, one of which is the Federal Open Market Committee (FOMC). The FOMC regulates open market operations, which is the buying and selling of U.S. Treasury and federal agency securities. By buying securities, extra reserves are added to the banking system, so interest rates fall. By selling, reserves are lowered and interest rates rise.

The FOMC is made up of twelve members, which include the seven members of the Board of Governors of the Federal Reserve System, the president of the Federal Reserve Bank of New York, and four of the remaining eleven Reserve Bank presidents, who each serve a one-year term on a rotating basis. The FOMC holds eight meetings each year. The purpose of these meetings is for the Committee to review current economic and financial conditions, and then decide the best course of action to take when setting monetary policy. Their policy goals are always to keep prices stable and the economy growing.

One way they accomplish these goals is by establishing the federal funds rate. (This is the rate that banks charge when they make an overnight sale to other banks of the money they keep deposited at the Federal Reserve.) At each meeting, the FOMC raises, lowers, or keeps the fed funds rate the same. This has a direct impact on mortgage rates.

If you want to know where interest rates are headed, keep your eye on the Federal Reserve. Their decisions are reported in the business section of all major newspapers.