Not Joined at the Hip: The Relationship between the Fed Funds Rate and Mortgage Rates

A time-honored, but flawed, assumption about the relationship between mortgage rates and interest rates has been turned on its head as the two have moved in opposite directions following the Federal Reserve's interest rate cuts over the past year.

In an economic climate where the notion that mortgage rates typically move in the same direction as the fed funds rate is not playing out, some prospective homebuyers seek insights from the internet. The following exchange appeared on a popular mortgage site before the Federal Open Market Committee (FOMC) met in September, when a rate cut was widely anticipated:

Q: "I was just offered to lock my rate at 6 percent. Should I lock that in now or see if there's going to be a rate cut after the Federal Reserve meeting?"

A: "I say lock. I'm locking today. Fed rates aren't mortgage rates."

Homebuyers scrutinize mortgage rates as they have become one of the primary factors driving the national decline in home ownership, according to an Atlanta Fed data tool, the Home Ownership Affordability Monitor. Mortgage rates rose above 5 percent in April 2022, exceeding 5 percent for the first time since February 2011, and have remained above 5 percent since then, according to Freddie Mac's 30-year fixed rate mortgage average in the United States.

But the Federal Reserve doesn't set mortgage rates. Instead, the Fed sets short-term interest rates-often called the fed funds rate-in an effort to fulfill its dual mandate from Congress: promoting maximum employment and stable prices. The Fed's short-term rates factor into how banks and financial institutions set many other rates, such as those for business loans, credit cards, and auto loans. And, of course, mortgages.

Atlanta Fed housing researchers keep a close eye on the relation among mortgage rates, the fed funds rate, and other factors that influence the housing market in an effort to stay abreast of the nation's housing sector, which Atlanta Fed president Raphael Bostic has described as an essential part of the economy, central to employment, economic mobility and resilience, and people's ability to build wealth.

Kris Gerardi and Domonic Purviance, both of the Atlanta Fed, explained that the presumed connection between mortgage rates and the fed funds rate is a misconception. For the past 20 years, mortgage rates have been more closely associated with the interest paid on 10-year Treasury notes than with the fed funds rate set by the FOMC, according to Gerardi, a financial economist who studies real estate finance and housing economics, and Purviance, a subject matter expert who analyzes risk in the housing market and threats it could pose to the financial system.

"While mortgage rates do, typically, move fairly closely with short-term interest rates like the fed funds rate, they are more strongly linked to longer-term rates such as the 10- or 20-year Treasury yield," Gerardi said. "This is because the average life of a mortgage is around seven to 10 years."

Gerardi observed that many factors determine longer-term yields on Treasuries and that the Fed's short-term interest rates are just one factor. Others include the market's expectation for economic growth, the federal government's fiscal policies on spending and taxation, inflation expectations, lender capacity as homeowners refinance their mortgages, borrowers' credit risk, and so forth. Gerardi said, "This means that, at times, mortgage rates and short-term rates can move in opposite directions."

Purviance elaborated on the heightened risk lenders face in the form of potential mortgage refinancing when rates are reduced. Current mortgage rates are "heavily influenced by the elevated pay-off risk as borrowers refinance," Purviance said.

"When rates are elevated, the expectation is that borrowers will refinance when rates eventually decline," Purviance said. "As such, investors expect a premium for mortgage-backed securities to ensure that they get as much of their return sooner rather than later. This is why the spreads between mortgage rates and the 10-year have remained elevated."

Gerardi provided evidence showing that, during the period from September 2024 to January 2025, the 10-year Treasury yield increased by about 90 basis points, despite the fact that the fed funds rate had decreased by approximately 80 basis points.

Figures provided by Freddie Mac yield a granular view of the trendline Gerardi described and show that the trend continued after a rate cut in September 2025.

In September 2024, following the Fed's half-point cut that was the first rate reduction since 2020, mortgage rates rose from 6.09 percent to 6.84 percent between September 19, 2024, and November 21, 2024, a high that was followed by a decline. The Fed reduced rates two more times in 2024 and held them steady until September 2025. The Fed in September cut the rate by a quarter-point, and mortgage rates increased from 6.26 percent to 6.34 percent between September 18, the day after the rate cut, and October 2, when rates began to ebb.

Purviance said the net effect of the current mortgage rate situation compels housing market watchers to consider a variety of factors to understand the potential direction of mortgage rates. The price of the dwelling itself cannot be overlooked, he said. "Affordability has remained strained despite the overall moderation of mortgage rates from their most recent peak," Purviance said. "This is because home prices have remained elevated."