How the Federal Reserve Impacts Real Estate—and What It Really Means for Buyers and Sellers

Dec 13

When people talk about mortgage rates rising or falling, the Federal Reserve—often called “the Fed”—usually enters the conversation. While the Fed doesn’t set mortgage rates directly, its policies strongly influence borrowing costs, housing affordability, and overall market activity.

Understanding how the Federal Reserve operates can help buyers and sellers make more informed real estate decisions, especially during periods of economic uncertainty.

What Is the Federal Reserve, and What Is Its Purpose?

The Federal Reserve is the United States’ central bank. Its primary responsibility is to keep the economy stable and functioning smoothly. To do that, it focuses on two primary goals, known as its dual mandate:

Maximum employment
Stable prices, with inflation typically targeted around 2 percent

To balance these goals, the Fed manages monetary policy—essentially controlling how much money flows through the economy and how expensive it is to borrow.

How the Federal Reserve Influences Mortgage Rates

The Fed does not directly set mortgage rates. Banks and lenders ultimately determine those. However, the Fed’s decisions influence the environment in which lenders operate, which in turn affects mortgage pricing.

Here are the three main ways the Fed impacts interest rates.

1. The Federal Funds Rate

Banks often lend money to one another overnight to meet short-term cash needs. The average rate they charge is called the federal funds rate.

The Fed doesn’t set this rate outright, but it sets a target range. When the Federal Open Market Committee (FOMC) meets—eight times per year—it decides whether to raise, lower, or hold that target range.

Because this rate influences borrowing costs across the financial system, lenders use it as a reference point when pricing loans, including mortgages.

2. Interest on Reserve Balances (IORB)

The Fed also pays banks interest on money they keep in reserve. This is known as interest on reserve balances (IORB), and unlike the federal funds rate, the Fed directly controls it.

When the Fed lowers this rate, banks are encouraged to lend more money, which can lead to lower mortgage rates.
When the Fed raises this rate, banks may hold more cash in reserve, reducing lending and pushing mortgage rates higher.

This tool allows the Fed to either stimulate or cool economic activity.

3. Open Market Operations

Another powerful tool is open market operations, where the Fed buys or sells financial assets such as U.S. Treasurys and mortgage-backed securities (MBS).

When the Fed buys these assets, more money enters the system, generally lowering interest rates. This approach—used heavily during the pandemic—is known as quantitative easing.
When the Fed sells assets, it removes money from circulation, which typically raises interest rates. This is called quantitative tightening.

When the Fed purchased mortgage-backed securities in large volumes, it increased competition among investors, allowing mortgage rates to fall as investors accepted lower returns.

Why Fed Independence Matters

The Federal Reserve operates independently from Congress and the White House. This independence is critical.

If investors lose confidence in the Fed’s ability to make data-driven decisions—based on inflation and employment rather than politics—long-term interest rates can rise, even when the Fed cuts short-term rates.

This is why mortgage rates don’t always move in lockstep with Fed announcements. If inflation remains elevated, mortgage rates can increase despite rate cuts.

What Typically Happens to Real Estate When the Fed Moves Rates?

While every market cycle is different, these are common patterns:

When the Fed raises rates:

Mortgage rates usually rise (though not always immediately or proportionally)
Buyer competition tends to cool
Home price growth often slows or levels off

When the Fed lowers rates:

Mortgage rates usually decline
Buyer competition increases
Home prices often rise due to stronger demand

The Lock-In Effect: A Hidden Market Force

One unintended consequence of rising rates is the lock-in effect.

Homeowners with very low mortgage rates may choose not to sell because they don’t want to give up their favorable financing. This reduces housing supply—even when demand softens.

As a result:

Inventory stays tight
Prices can remain elevated
Fewer homes change hands

For buyers, this can mean continued affordability challenges. For sellers, it can mean less competition—but fewer overall transactions.

The Fed Is Important—But It’s Not the Only Factor

The Federal Reserve plays a significant role in shaping economic conditions and influencing interest rates. Its policies affect housing supply, buyer demand, and affordability.

That said, real estate values are also influenced by many other factors, including: