What is the interest rate the Federal Reserve banks charge for loans to banks?

When you hear the term “federal funds rate,” it refers to the target interest rate set by the Federal Open Market Committee (FOMC), which is a part of America’s central banking system, the Federal Reserve. The federal funds rate is the suggested interest at which banks lend money to each other and was designed to help keep the U.S. economy operating smoothly.

In other words, it’s a fiscal tool used to control the money supply in the system and help keep inflation in check when commerce begins to overheat or stimulate the economy when it slows down.

The federal funds rate (also known as the fed funds rate, federal interest rate or federal reserve rate) essentially provides a helpful means through which the Federal Reserve can influence interest rates and borrowing. In practice, raising the federal funds rate makes it more expensive for individuals or organizations to borrow funds. Lowering it makes it easier for them to engage in borrowing.

In effect, if the federal funds rate is raised, money becomes less available, and short-term interest rates go up, which helps combat inflation. If it’s decreased, money becomes more readily available, and short-term interest rates sink, which helps stimulate economic activity.

Of course, the Fed can’t simply flip a switch and immediately transform the shape of the entire market or engage in discussions with every lending provider when it wishes to change financial policy. Rather, it influences lending practices by exercising control over a target benchmark rate – the federal funds rate – whose changes then trickle down to the rest of the economy.

When you hear that the Fed has raised or cut interest rates, this is what is being referred to: An adjustment to the federal funds rate.

Changes to it can in turn impact mortgage and loan interest rates, or interest rates on credit cards, savings accounts and certificates of deposit (CD). In other words, various loan and investment vehicles can be both directly and indirectly influenced by changes to the fed funds rate.

The Federal Reserve doesn't set mortgage rates, but its actions indirectly affect mortgage rates. As of its December 2022 meeting, the Fed has raised a benchmark interest rate by a total of 425 basis points, or 4.25 percentage points, in 2022. Mortgage rates have risen less, with the average interest rate for a 30-year fixed-rate mortgage going from around 3.2% in early January to 6.3% in early December.

Mortgage rates are influenced by many elements, including the inflation rate, the pace of job creation, and whether the economy is growing or shrinking. The Federal Reserve's monetary policy is a factor, too, and is set by the Federal Open Market Committee.

What the Federal Reserve does

The Federal Reserve is the nation's central bank. It guides the economy with the twin goals of encouraging job growth while keeping inflation under control.

The FOMC pursues those goals through monetary policy: managing the supply of money and the cost of credit. Its main monetary policy tool is the federal funds rate, which is the interest rate that banks charge one another for short-term loans. Although there's no such thing as "federal mortgage rates," the federal funds rate influences interest rates for longer-term loans, including mortgages.

The FOMC meets eight times a year, roughly every six weeks, to tweak monetary policy. At the conclusion of each meeting, the committee releases a statement explaining its reasoning. Three weeks later, the meeting's minutes are released, serving Fed nerds even more details.

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Do mortgage rates follow Fed rates?

The Fed and the mortgage market move like dance partners: Sometimes the Fed leads, sometimes the mortgage market leads, and sometimes they dance on their own.

The federal funds rate and mortgage rates usually move in the same direction. But it's sometimes hard to say whether mortgage rates follow the Fed's actions or the other way around.

The FOMC prefers to give investors a heads-up whenever it plans to raise or cut short-term interest rates. Members of the committee advertise their intentions by sprinkling hints into their public speeches. By the time the committee meets, there's usually a consensus among investors as to whether the Fed will cut rates, raise them or keep them unchanged.

As that consensus solidifies before an FOMC meeting, mortgage rates usually drift in the direction that the Fed is expected to move. Often, by the time of the meeting, mortgage rates already reflect the expected rate change.

At the same time, mortgage rates move up and down daily in reaction to the ebb and flow of the U.S. and global economies, which are the same developments that the Fed responds to.

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What is the current federal funds rate?

The Fed raised the federal funds rate seven times in 2022. Four of the increases were by an aggressive 75 basis points each. The last increase of the year was by a more moderate 50 basis points.

Occasionally, the Fed and mortgage rates move in opposite directions; this happened in December, when mortgage rates fell in response to declining inflation, even as the market correctly expected the Fed to raise the federal funds rate to restrain inflation even more.

Federal funds rate and HELOCs

Although there's merely an indirect link between mortgage rates and the federal funds rate, the Fed does have a direct influence on the rates charged on home equity lines of credit, which typically have adjustable rates.

Interest rates on HELOCs are linked to the Wall Street Journal prime rate, which is the base rate on corporate loans by the largest banks. The prime rate, in turn, moves with the federal funds rate. The prime rate rose to 7.5% after the Dec. 14, 2022, Fed meeting.

On a HELOC with a $50,000 balance, a rate increase of half a percentage point would increase the monthly interest payment by $20.83.

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