How the Secondary Market and the Fed Impacts Mortgage Rates

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When you take out a home loan, you may assume that your lender is looking to make money off the mortgage interest you’ll be paying for years to come. The fact is, very few mortgage lenders work that way.

What Happens to Your Mortgage After You Finalize It?

Lenders are also called originators. They may be a bank, a credit union, or other type of financial institution.

Typically, they make their money through the fees they charge for originating the loan and rely on small amounts in volume to stay profitable.

A lender can keep that loan in its portfolio but most quickly turn the mortgages by selling them to investors via a secondary market. Those investors, and not the lenders, are the ones who want to get paid regularly by the interest charged on the mortgage loans they hold.

Lenders benefit from this arrangement because these transactions constantly create an infusion of cash that they can use to generate more mortgages and collect more in fees. Cash flow would be problematic if they had to keep those loans on their books and wait for interest payments to dribble in month after month.

The secondary market investors keep funds circulating so that loan originators don’t run out of money for new mortgages.

The Role of Fannie Mae, Freddie Mac, and the FHA

Mortgages are typically sold to investors through Fannie Mae, Freddie Mac, or the FHA. They require that the loans they handle meet certain standards.

In return, they provide specific guarantees, making them safer and more attractive to investors, including insurance companies, pension funds, and securities dealers. 

Because these guarantees make mortgages more reliable, investors are willing to accept lower returns. That trickles down to borrowers who will enjoy lower mortgage rates. The efficiencies of scale provided by this arrangement also produce lower home loan interest rates.

Fannie and Freddie buy mortgages and bundle them together for resale in mortgage-backed securities (MBS). These are highly liquid investments, meaning that they can be readily bought and sold.

The level of return is determined by the current and anticipated condition of the economy. When the economy is on an upswing, future yields are expected to be better than current yields.

Investors, therefore, will hold off buying until higher yields materialize. That drives home mortgage interest rates up because lenders cannot sell their loans at lower yields.

When the economy is in a downturn, investors buy up what’s available to avoid being stuck with lower yields later. That pushes mortgage rates down as investors are clamoring to buy before yields get too low.

The Federal Reserve’s Role in Mortgage Rates

Another metric to keep your eye on is the Federal funds rate. That is the rate that banks charge when they make an overnight sale to other banks of the money that they keep deposited at the Federal Reserve, aka the Fed.

The Fed funds rate is set during meetings of its Federal Open Market Committee (FOMC), which regulates the buying and selling of U.S. Treasuries and federal agency securities.

The FOMC holds eight meetings each year, where they review economic and financial conditions and decide the best course of action to take to set monetary policy and keep the economy stable.

A decrease in the rate will stimulate growth, and an increase will slow growth. In periods of high inflation, the FOMC may raise interest rates, and in a period where they need to stimulate the economy, rates are lowered. 

At each meeting, members of the Fed lower, raise, or maintain the Fed funds rate, which directly impacts mortgage rates. 

For example, a 0.25 percent increase in mortgage rates on a $250,000 home loan equates to $35 more monthly in mortgage payments. That’s not a huge bump, but a full percentage point jump can have a significant impact if you’re budgeting tightly and deciding when to buy a home.

The Fed funds rate also impacts the stock market because stock market trends and the Fed influence each other. If the market is struggling and in a downward trend, the FOMC may reduce the fed funds rate and free up the money supply.

Conversely, if the market is on a tear, the Fed may increase the rate to keep the economy from overheating.

Unemployment and inflation levels, trends in the stock and Treasury bond markets, and the federal funds rate impact mortgage loan rates. None of these alone will give you surefire insight into the future of rates, but by keeping your eye on them, you can sense where they are headed.

Also, adjustable-rate mortgages (ARMs) more closely follow Fed moves and tend to rise or fall more rapidly than fixed-rate mortgages.

That can help you decide when to jump into the home buying market and could save you thousands of dollars in the long run when your research is accurate.

More Challenging to Qualify for a Loan

Higher interest rates create higher payments, raising the possibility that more people may drop out of the housing market because they can’t afford the higher payments or qualify for a higher interest loan.

Higher home loan payments can increase a debt-to-income ratio, preventing some people from qualifying for a loan.

Less buying power could slow the rise of home prices as fewer people shop for homes. That leads to less competition in hot markets, potentially lessening home price increases and making homes more affordable even as loan costs increase. 

David Mully

David Mully is president and CEO of Lender Insider, a mortgage consulting firm. With 26 years in the mortgage industry, he has worked as both a mortgage loan officer and in the business-to-business sector of the industry. He is the former author of the weekly “Mortgage Search” column for Observer and Eccentric Newspapers. You can read his blog at

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