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How the Federal Reserve Is Playing a Huge Role in Leveling the Playing Field for First Time Home Buyers in the US

Many Americans do not often pay a great deal of attention to what the Federal Reserve does, but when they buy a home, the Fed can have an impact on interest rates and home loan affordability. But the fact is the Federal Reserve's decisions have a major effect on all of our economic and personal lives.

One of the major tasks of the Fed is to set monetary policy, which it mostly does by increasing or decreasing the federal funds rate. The mission of the Federal Reserve is to provide economic growth in the country with as little inflation as possible. It does this by changing interest rates through several tools in its financial toolbox.

Overview

When the Federal Reserve decides to increase interest rates – which it finally did at the end of 2015 by ¼ point – it makes it a bit harder for people who are shopping for a mortgage or a car loan. On the other hand when the Fed decides to lower interest rates, making the same purchases gets easier.

In recent years, after the great market crash of 2007-2008, the Fed has kept interest rates at near record lows as the US economy was in the doldrums. They have increased rates in recent months, but interest rates overall are still very low as of 2016. It remains clear that for 2017 and 2018, the Fed wants 1st time homebuyers to be able to get into a mortgage and buy their own home.

Details on How the Feds Affect and Help Homeowners

Let's take a closer look at how the Fed can change the federal funds rate, which can have positive effects on home buyers and home owners. Keep in mind that even when the Fed raises rates, this will likely have a negative effect on some home buyers who will have to pay a higher interest rate. The same action, however, can also have positive effects on the same people, such as make it more profitable to save money in savings accounts.

  • Via open market operations, the Fed buys US Treasury securities to reduce the supply of US government debt. This hikes the price and brings down the interest rate on those securities. Or, it can sell Treasuries into the market to boost supply. This lowers the price and boosts interest rates.
  • The Fed sets the discount rate. This is the rate that banks can borrow from one of the regional Federal Reserve Banks. If this rate is hiked, banks have higher costs to borrow money and will reduce lending. This increases interest rates. If this rate is dropped, banks will make credit more available, and interest rates drop.
  • The Fed establishes reserve requirements for banks, which they are required to hold for the deposits on their books. If reserve requirements are hiked, banks will lend less. If they are loosened, banks tend to lend more.

More Ways the Fed Influences Homeowners and Consumers

Mortgage Rates

When the Fed drops the federal funds rate, lenders can offer home loans cheaper. They then can lower interest rates that you pay for a fixed rate mortgage.

In the last six years, the Fed has kept the federal funds rate so low to 'goose' the housing market. The Fed has been trying hard to make home ownership affordable so that more first time homebuyers can stop renting.

Mortgages are tied to the 10 year Treasury rate.

Credit

The Fed's financial actions have a major effect on the availability of credit for most consumers. When the Fed increase the US money supply by buying US government bonds, lenders usually will give more credit to borrowers. This expands the reach for people seeking home loans for bad credit.

Prices

The actions of the Federal Reserve also have an effect on the prices you pay at the pump, grocery store and just about any retail outlet you can imagine. This is because the cost/availability of money affects what consumers will pay for goods and services. When money is cheap to borrow and there is a lot of it, there will be higher demand and prices go up.

When the economy is booming, the Fed often will raise interest rates, which indirectly can cause prices to rise, to reduce the impact of inflation. Keeping inflation low is a boon to most home buyers, home owners and consumers as it makes their money go further.

Job Market

The Federal Reserve has an indirect but substantial effect on consumers' ability to get and hold a job. Lowering interest rates increases borrowing by businesses, which can lead to business expansion.

At every meeting of the Federal Reserve, policymakers consider current labor market data as they try to achieve the highest amount of employment in the US:

  • Changes in payroll
  • Hiring
  • Participation in labor force
  • How long people are unemployed

Credit Card Rates

Most credit card interest rates are variable and are tied to the prime rate. That rate is normally approximately three percentage points over the federal funds rate. When the federal funds rate changes, the prime rate will change too. This will make it either more or less expensive to carry balances on credit cards.

When a low rate is set, the consumer is encourage to buy more or to do home repairs. If they set a higher rate, the Fed wants to curb consumer spending in a stronger economy to prevent inflation.

CD Rates

Many savers have not been pleased in recent years that the Fed has kept interest rates so low. For example, retirees who want to live on certificate of deposit interest find that difficult with rates low.

One of the reasons that the Fed keeps rates low is to encourage consumers to invest in stocks and bonds, which encourages economic growth.

Auto Loan Rates

The federal funds rate has an effect on medium term loans, such as car loans. Whether the lender is a bank, credit union or something else, auto loans are tied to the prime rate, which moves up or down based upon the federal funds rate.

Bottom Line

The actions of the Federal Reserve in setting interest rates have a major effect on first time homeownership, home owners, and consumers generally. Recent policy to keep interest rates low has been a major plus for 1st time homebuyers. It looks as if the Fed will continue to keep rates low, so that potential buyers can get into a home with a low interest mortgage. Top 8 Reasons Home Buyers Get Turned Down for a Mortgage Loan

 

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