What a Fed rate hike could mean for mortgage rates (and what borrowers need to do now)

Over the last couple of years, mortgage rates have been moving in the wrong direction for prospective homebuyers. And, those rate shifts have been even less ideal over the past few months, in particular. Case in point? As of mid-September, the average 30-year fixed mortgage rate is sitting at about 7.43%, up from about 6.43% in early July. That 1% rate jump may look modest on paper, but it can translate into a noticeably higher monthly payment, especially on a large home loan.

And borrowers could soon face another mortgage rate shift. The Federal Reserve is meeting this week, and persistent inflation has put the possibility of another rate hike back into focus. Fed Chairman Kevin Warsh recently indicated that policymakers could have more work to do if they don't gain confidence that inflation is moving sustainably toward the Fed's 2% target, and experts now largely expect a rate hike to occur at the close of the Fed meeting on September 16th.

That doesn't mean mortgage rates will automatically rise if the Fed increases its benchmark rate this week, though. The relationship between the two is complicated. Still, borrowers who plan to buy a home or refinance soon may want to pay close attention to what could happen next.

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What a Fed rate hike could mean for mortgage rates

It's important to understand that the Federal Reserve does not directly set mortgage rates. When Fed officials vote to raise the federal funds rate, they are changing a short-term benchmark that influences borrowing costs throughout the economy. Fixed mortgage rates, meanwhile, tend to be more closely tied to longer-term bond yields, including the 10-year Treasury yield.

That said, those yields can move based on many of the same factors that influence Fed policy, particularly inflation and expectations about where interest rates are headed. And there are already signs of upward pressure in the bond market, as the 10-year Treasury yield rose from 4.80% on September 8 to 4.96% on September 11, according to Federal Reserve data.

So, if the Fed raises rates and signals that additional hikes could follow, mortgage rates could face more upward pressure. Investors may demand higher yields on longer-term bonds if they expect inflation to remain elevated or monetary policy to stay restrictive for longer, and lenders could respond, in turn, by charging higher mortgage rates.

But a Fed rate hike doesn't guarantee that outcome. If markets have already fully priced in a Fed increase, mortgage rates could experience very little movement after the announcement. And, rates could even decline if the Fed's accompanying guidance makes investors think future hikes are less likely than previously expected.

That's why borrowers shouldn't assume that a quarter-point Fed hike, for example, will result in a quarter-point increase in mortgage rates. The bigger issue may be what Fed officials say about inflation and the path for monetary policy in the months ahead.

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What mortgage loan borrowers need to do now

With mortgage rates already elevated and the Fed's next move uncertain, trying to time the market can be difficult. Borrowers may be better served by focusing on the parts of their mortgage they can control, including the following:

Shop around before choosing a lender: Mortgage offers can vary significantly from one lender to another, even when they're issued on the same day. Getting quotes from several mortgage lenders can help you find a lower rate or better loan terms, and comparing multiple quotes can potentially save you thousands of dollars in interest charges over time.

Consider locking your rate if the numbers work: If you've found a home, have a mortgage offer you're comfortable with and are worried about rates climbing, a mortgage rate lock can protect you from increases before closing. But locking in a mortgage rate also means you may not automatically benefit if rates fall, unless your lender offers a float-down option. So, be sure to understand the lock period, fees and other conditions before agreeing.

Look at the payment, not just the headline rate: Small rate differences can matter when you're financing hundreds of thousands of dollars to buy a home. For example, the principal and interest on a $300,000 30-year mortgage would be about $1,896 per month at a rate of 6.5%, compared with roughly $1,996 at 7%. That's about $100 more each month before accounting for taxes, homeowners insurance or other housing costs.

Strengthen your borrower profile: You can't control Treasury yields or Fed policy, but you may be able to qualify for a better mortgage loan offer by improving your credit, lowering your debt-to-income ratio or making a larger down payment. Those steps can become particularly valuable when market rates are high because even a small reduction in your individual mortgage rate can produce meaningful long-term savings.

And if you're still early in the homebuying process, don't rush into a purchase solely because you're worried that rates will rise. A mortgage has to fit your budget at today's rate, not at the lower rate you hope will become available later. Refinancing may be an option if borrowing costs eventually fall, but there's no guarantee about when or whether that opportunity will emerge.

The bottom line

A Fed rate hike could put additional upward pressure on mortgage rates, but the outcome isn't automatic. Mortgage rates respond to a much broader set of factors, including inflation expectations, Treasury yields and investors' outlook for future Fed policy. With the average 30-year mortgage rate already at 7.43%, borrowers have good reason to keep a close eye on those factors now. Rather than trying to predict exactly what the Fed will do to mortgage rates, though, it may make more sense to compare lenders, evaluate rate lock options and make sure any mortgage payment you're considering works comfortably within your current budget.