What Happens When the Fed Raises Interest Rates?

When the Federal Reserve raises interest rates, the cost to borrow many types of credit tends to rise, as well. If you’re a home buyer, though, an increase won’t necessarily raise mortgage rates or take you out of the market. Usually, by the time the Fed announces a rate hike, mortgage lenders have already anticipated and priced that move into their rates. 

Why does the Fed increase interest rates? 

The Federal Reserve increases interest rates in support of two main objectives: stable prices and maximum employment. One way it achieves those goals is to raise or lower the federal funds rate.

When inflation is climbing too fast, for instance, the Fed raises rates to bring price growth back on track. Higher rates slow spending and encourage saving, helping the economy from overheating.

What determines interest rates? 

The Federal Reserve helps determine interest rates by way of raising or lowering the federal funds rate, the interest rate range at which banks can charge one another to borrow money. This money moves between banks day to day, as their balances change, in order to maintain liquidity and ensure they have enough cash to meet operational needs.

The federal funds rate is the benchmark for many other rates across the economy, including the prime rate — the best possible interest rate banks and lenders offer to highly qualified customers.

The federal funds rate and prime rate aren’t directly tied to mortgage interest rates, though. Mortgages are long-term loans, typically paid back over 15 or 30 years. The federal funds and prime rates more often impact short-term and variable-rate loans.

Does the Fed determine mortgage rates?

No. The Federal Reserve doesn’t determine mortgage interest rates — but there’s a link between them.

Ahead of a Fed decision, mortgage lenders pay close attention to what analysts think the Fed may do, both now and in the future. If the expectation is for a Fed hike, or hint at higher fed funds rates in the future, mortgage lenders tend to raise their rates in anticipation of that move. If the Fed doesn’t do what’s expected, lenders may also raise their rates in response to the uncertainty.

Who benefits the most from rising interest rates?

When interest rates rise, banks, credit issuers, insurance companies and savers may benefit.

• Banks: While banks pay out more interest to savers in times of rising rates, they also charge more interest on mortgages and other types of loans. That higher interest means the bank makes more money, but also exposes it to increased risk of borrower default.
• Credit issuers: When rates rise, the rates on credit cards and other variable-rate loans also rise, so credit issuers make more money on interest. As a credit user, it’ll become more expensive to charge your card.
• Savers: Whether you put your money into a savings account or fixed-income investment like a CD, rising rates mean you’ll earn more interest on that money. 
• Insurance and pension players: With large bond portfolios, insurance companies and pension fund holders benefit from rising rates because they’re able to reinvest at higher yields.

What impact do rising rates have on the housing market?

Generally, the housing market tends to cool when interest rates trend up. A buyer may decide to wait for more affordable rates, or a seller may decide to stay put because they can’t afford to move. 

What rising interest rates mean for home buyers

Although mortgage rates aren’t set by the Federal Reserve, they can and do move ahead of anticipated Fed policy, and often after a surprise Fed decision.

That may make a mortgage unaffordable for some buyers, reducing demand for homes. The lower demand may translate to lower home prices and more seller price cuts. If you can still afford to buy a home, that could be a good thing — you’ll have less competition from other buyers, and potentially more negotiating room with sellers.

You may also find fewer options, though. When interest rates are rising, many homeowners opt to stay put with their current mortgage rather than move and get a new loan at a higher rate. That may reduce the amount of homes for sale. 

In addition, a Fed hike raises rates on revolving or variable-rate loans, like credit cards. If you have this type of debt, that can make it harder to save for a down payment and closing costs. On the flip side, if you’re putting aside home-buying funds in a savings account, a Fed increase may help those savings grow. 

Zillow Home Loans’ BuyAbility tool can help you shop for homes and see which homes fit comfortably within your budget based on real-time interest rates.

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What rising interest rates mean for sellers

When interest rates are rising, it may be more difficult to sell a home. Higher mortgage rates raise the monthly payment, reducing buying power and limiting the pool of listings buyers can afford.  More buyers may decide to leave the market until rates improve, which may mean less offers and more days on market. Some sellers may find they aren’t getting offers at the price they want. If you accept a lower offer, you won’t profit as much, which gives you less to work with when you go to purchase your next home. 

Similarly, higher interest rates may make it harder to buy that next home. If you locked in an affordable rate when you bought your current home, a new mortgage at today’s rates may cost too much.

What rising interest rates mean for homeowners

If you already have a mortgage at a fixed rate, rising interest rates won’t impact your loan. You’ll still have the same monthly principal and interest payment, and rate, as when you closed.

ARM loans are more complicated. WIth this type of mortgage, your rate can’t increase in the introductory period of the loan, but it can if you’re in the adjustable or variable-rate period. Generally, if the Fed raises rates, your rate and the monthly principal and interest payment may rise, as well.

In addition, homeowners looking to refinance their mortgage may hold off until rates come down. In most cases, you won’t want to trade your current mortgage with a lower rate for a new loan at a higher rate. Likewise, some homeowners wait to take out a home equity line of credit (HELOC) or home equity loan until they can get better rates.

What rising interest rates mean for renters

As a renter, rising interest rates may impact your finances. When buyers get priced out of the market, they turn back to renting, which drives up demand for rentals. That can push landlords to raise rents. 

If you’re saving up to buy a home, though, rising interest rates may help you. When interest rates increase, the rates on savings accounts do, too, which means you’ll earn more interest on your deposits. That can help you save more, sooner.

However, if you have credit card or other types of variable-rate debt, you may not be able to save as much. Instead, you’ll be paying more in interest.

Final thoughts on navigating rising rates

The Federal Reserve raises interest rates to keep the economy, employment and inflation in check. That decision doesn’t directly affect mortgage rates, and generally, it’s not a good idea to try to time your home purchase based on the Fed. Most of the time, mortgage lenders anticipate a Fed increase and build it into mortgage rates long before the Fed’s decision is final.

Still, in times of rising rates, there are varying impacts on the housing market. Homeowners with fixed loans rest easier, while those with adjustable-rate loans may need to brace for higher payments. Home buyers may find their budget stretched, sellers may see fewer offers and renters may feel the squeeze of a tighter market. 

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