A Brief Primer on Interest Rates

September 5, 2025

A brief primer on Mortgage Rates

Many factors affect mortgage rates, but the primary source of movement is the Federal Funds Rate set by the Federal Reserve.

How the Fed influences interest rates

While the Fed doesn't set mortgage rates, "the Fed Rate" indirectly determines consumer borrowing rates including mortgages.

I'm often asked how this works, and its not easy to explain as there is no direct correlation, but very simply if you think of consumer banks selling a product - the loan - the Fed Rate is the cost of that product to the seller (bank), and the difference between the loan rate and the Fed rate is their profit or "The Spread".

Cost of Borrowing for Banks:

The federal funds rate is the rate at which banks lend to one another overnight. When the Fed changes this rate, it changes how much it costs banks to borrow money.

Ripple Effect:

Banks then pass these higher or lower borrowing costs on to their customers, influencing the rates for various loans, including mortgages.

Benchmark for Mortgages:

While not a direct link, the Fed's actions influence the yields on Treasury bonds, particularly the 10-year Treasury yield, which serves as a primary benchmark for 30-year fixed-rate mortgages.

In between Fed Meetings

The Fed meets 8 times a year and decides whether to change rates or keep them the same at these meetings, so you might think that mortgage rates would change only every 6 weeks or so when these meetings occur, but in reality during the intervals, lenders adjust their rates based on what they predict the Fed will do a their next meeting among other factors.

Reading the Fed Tea Leaves

So if for instance there's a strong jobs report, or inflation data is released that's higher than expected, these will increase the chance the Fed will raise rates (or not change them if they were expected to be lowered), and mortgage rates will rise accordingly.

Consequently, when the Fed actually does lower rates, it often has no effect on mortgages, as the move has already been "baked in" to rates.

"The Spread"

The margin banks feel they need to charge on loans can have a significant effect on rates as you can see below in recent years it has varied between 1.5% and 3%.

No doubt banks would like to make as much margin as possible, but market forces drive these spreads & those forces are largely a consensus on risk.

One major factor that drive's spreads is anticipated "velocity". If banks think rates will continue to go down, and consumers will refinance within a few years, they will want to price in a premium on their spread to compensate for expected "velocity" or early redemptions.

A "normal" spread is considered to be between 1.5% - 2%, so as you can see we are still considerably above that range. This means as the Fed lowers rates, Mortgage rates have room to decline faster than the Fed Rate.

Political Meddling

You've likely heard the news that the president is trying to exert more influence over the Fed. Traditionally the Fed is independent which allows it to doe its job without worrying about the popularity of its decisions.

If Trump is successful, a politically loyal Fed would likely lower rates faster as this is what he has advocated consistently. Good news for mortgage rates in the short term, but.......there would be a price.

Reduced Fed credibility: The core danger, according to economists, is that presidential meddling would destroy the Federal Reserve's credibility and independence.

Higher inflation: With reduced independence, financial markets might lose faith in the Fed's commitment to fighting inflation. This could cause inflation expectations to rise.

Higher mortgage rates: Mortgage rates are tied to the 10-year Treasury yield, which is influenced by market expectations of long-term inflation. If markets anticipate higher inflation due to Fed meddling, they will demand higher yields on Treasury bonds, pushing long-term borrowing costs—and thus mortgage rates—higher. We might see spreads far in excess of anything seen under an independent Federal Reserve.

My Advice?

If you're considering buying a home, but considering waiting until interest rates are lower, My advice is

Don't Wait!

Forgive me if you've heard me say this before, but the beauty of the 30 year fixed rate mortgage - available almost exclusively in America 🇺🇸🇺🇸🇺🇸 - is that if you get a loan at the current rate and rates go up, you will be happy with the rate you got. If they go down, you can refinance to the lower rate.

However, if you wait and rates go up you're stuck with the new higher rates, and even if they do go down there will likely be more competition for the house you want pushing up the price you have to pay.

My Forecast

My best guess is that we may see rates dip under 6% next year, and maybe even get in to the mid 5% range. This would likely bring more buyers back into the market and prices in Marin would rebound.

Putting my money where my mouth is

My sense that this is a good buying opportunity is strong enough that I have got my pre-approval letter in hand and am actively searching for potential investment properties in Marin. I may not pull the trigger - I own my primary residence so anything else is just investing where I see opportunity in a market I know well - but I am ready.