How a Recession Can Affect Mortgage Rates

Mortgage rates are the interest rates paid on moneys that are given, on a temporary basis, from a lending company, such as a bank, to a borrower who is attempting to purchase a home. In other words, mortgage rates are the cost of borrowing money for a home loan. Like many other interest rates, mortgage rates depend on a variety of complicated and complex factors. A few determining factors that can be explained are the state of the economy, the government's response to the state of the economy, and the cause of the state of the economy.

The State of the Economy and Interest Rates

If an economy is in a recession, one way to attempt to improve conditions is through the use of monetary policy. Monetary policy is the Federal Reserve's way of increasing or decreasing the flow of money in the economy. During a recession, the Federal Reserve uses expansionary monetary policy in order to increase the amount of money in the economy. One feature of expansionary monetary policy is a decreased Federal Funds Rate. The Federal Funds Rate is, generally speaking, the interest rate that banks charge other banks that need money. The Federal Reserve considers adjusting the Federal Funds Rate on a set schedule, usually every 6 weeks. 

Federal Funds Rate and Mortgage Rates

Like many other interest rates, mortgage rates usually follow the trend of the Federal Funds Rate. As it becomes less expensive for banks to borrow money from other banks, banks become increasingly able to lend out money to their customers for less. Potential home owners looking to use home loans to purchase a house can therefore receive financing with less severe monetary consequences. The amount that home owners pay on their mortgages decreases as the mortgage rates decrease. 

Other Possibilities

Although, in most circumstances, a bad economy will lead to lower mortgage rates, the response of mortgage rates to a bad economy can vary depending on the type of recession that an economy is facing. If a recession is occurring because people are defaulting on their mortgages, lenders will be less likely to lower interest rates to extremely appealing levels. Another factor that can cause an increase in mortgage rates, even during a recession, is inflation. If the prices of goods are increasing at an undesirable rate and a recession is occurring because people cannot afford goods, then expansionary monetary policy (lowering the Federal Funds Rate) will amplify price increases and enhance the central issue. During a recession causes by inflation, mortgage rates will probably increase.