Whether you’re buying a home for the first time or a longtime homeowner thinking about refinancing, mortgage rates should be a top concern. Making sure you have the lowest rate possible on your mortgage is key to potentially saving up to thousands of dollars over the life of your loan.

One important factor that affects mortgage rates is the federal funds rate. This rate often makes headlines, but it may sound like financial jargon. To better understand how and why interest rates fluctuate — plus, how to get a good rate on your home loan — learn the definition of the federal funds rate and what it means for mortgages.

Understanding the Federal Funds Rate

The federal funds rate is the interest rate banks charge each other for loans overnight. When banks have excess cash on hand, they lend to other banks that need to boost their balances. The weighted average interest rate of all the loan negotiations between these banks is known as the effective federal funds rate.


The policymaking panel of the Federal Reserve, the country’s central bank, sets a target range for the federal funds rate. It influences the federal funds rate through open market operations — more on that later.

The federal funds rate is important because it’s the central interest rate of the U.S. financial market. It has an indirect impact on longer-term rates, such as the interest rates on mortgages, other loans, and savings accounts. So, knowing how the federal funds rate works could help consumers better understand how much a mortgage or refinance will cost them.

Who sets the federal funds rate?

The Federal Open Market Committee, which is the policymaking panel of the Federal Reserve, is responsible for determining the target federal funds rate. The 12-member committee comprises the board of governors of the Federal Reserve System, the president of the Federal Reserve Bank of New York, and rotating seats filled by the other Reserve Bank presidents.

How does the Fed set interest rates?

The FOMC meets eight times per year to consider changes to the target federal funds rate.

“The Fed has two main objectives for the economy: a strong labor market and stable prices,” says Nicholas LaClair, a pricing analyst and lock desk manager at Embrace Home Loans in Middletown, Rhode Island.

If those objectives aren’t being met, the FOMC may shift the target federal funds rate higher or lower. The Fed typically aligns the effective federal funds rate with the target rate through open market operations. This involves the purchase or sale of securities, specifically government bonds.

How does the federal funds rate work?

The goals set by the FOMC determine what steps the Fed will take to influence the federal funds rate.

“If the Fed wants to lower the federal funds rate, they will buy securities from banks, which will increase reserves and the money available to lend out,” LaClair says. With more money to lend, banks can charge lower interest rates.

On the other hand, if the Fed wants to increase the federal funds rate, it will sell securities. That reduces reserves and the amount of money that banks can lend.

“With less money available to lend out, banks will charge a higher rate,” LaClair says.

What does it mean when the rate goes down?

When the FOMC lowers the target federal funds rate, its goal is to stimulate economic activity and sustain growth.

“A low federal funds rate makes borrowing money less expensive and causes markets to heat up through broader investments, particularly in housing,” says Richard Steinberg, chairman of Nationwide Mortgage Bankers in Melville, New York.

What does it mean when the rate goes up?

If the target federal funds rate is raised, then the goal is to curb inflation, or the growth rate of the general cost of goods and services.

“A higher federal funds rate makes borrowing money more expensive, which causes a cooling effect on the economy to slow down growth,” Steinberg says. Those higher costs mean borrowers and lenders must be more selective when it comes to where they spend money.

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The Current Federal Funds Rate

Due to the stress on the financial market caused by the COVID-19 pandemic, the FOMC dropped its target federal funds rate to 0%-0.25% on March 16, 2020, where it remained near zero for two years.

On March 17, 2022, the FOMC raised the target rate to 0.25%-0.5%, with ongoing increases likely in the future. This decision was made to control inflation and keep the labor market strong.


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How Does the Federal Funds Rate Affect Mortgage Rates?

First, it’s important to understand that the federal funds rate represents a cost for banks, according to LaClair. The federal funds rate doesn’t affect mortgage rates directly — but it influences other factors that do.

The impact of the federal funds rate is immediately seen in short-term securities, Treasury bills, and money market accounts. Eventually, the ripple effect makes its way to the interest rates tied to mortgages, home equity lines of credit, credit cards, and auto loans.

When it’s cheaper for banks to conduct business, they can pass along the savings to borrowers via lower interest rates. So, if the federal funds rate is low, mortgage rates are also typically low.

Keep in mind that fluctuations in the federal funds rate won’t have an impact on your loan if you already have a fixed-rate mortgage, since your interest rate is set for the entire loan term. But if you have an adjustable-rate mortgage, your interest rate could change after the federal funds rate goes up or down.

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Tips for Getting a Good Mortgage Rate

Now that you have Fed interest rates explained, how do you qualify for the lowest mortgage rates? Here are some steps you could take to increase your odds of getting a mortgage with a low rate:

  • Save up a large down payment. Though it’s possible to put as little as 3% down, saving for a bigger down payment could help you secure a lower interest rate. By doing so, you would also face a smaller monthly payment and lower overall costs.
  • Improve your credit. Buying a house with no credit or poor credit can be difficult. So, if your credit score isn’t in great shape, spend some time improving it before applying for a mortgage. LaClair recommended aiming for a score of at least 740.
  • Consider paying discount points. By choosing to pay points, you increase your closing costs in exchange for a lower interest rate on the loan. Though you would pay more upfront, you’d end up paying less mortgage interest over time.

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The Bottom Line on the Federal Funds Rate

The federal funds rate is an important tool used by the Fed to keep the economy healthy. Changes to the Fed’s target rate trickle down to consumers and the interest rates they receive on everything from savings accounts to mortgages. While you can’t control the federal funds rate, there are other things you could do to get a good interest rate on your loan.