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federal reserve bank - washington dc The interest rates that banks charge for mortgage loans are most predominantly affected by the Federal Funds rate.  This "Fed Funds" rate is the rate at which depository institutions (banks) lend money to each other (usually overnight) from their deposits at the Federal Reserve Bank.  When you hear about the Fed "changing the interest rate," it is actually targeting a certain Fed Funds rate.

The Federal Reserve can't actually control the Fed Funds rate — it can't tell the banks what to charge other banks for overnight loans.  But it can engage in open market operations — the buying and selling of U.S. Treasury Securities — to affect how much money those banks hold in deposit.  When the amount of money that banks hold in deposit changes, the banks change the amount that they'll charge lend it out — the Fed Funds rate.  Achieving a targeted rate by engaging open market operations is as much an art as a science.  But by now the Fed has become fairly adept at knowing how many securities it needs to buy or sell in the open market to achieve its desired Fed Funds rate.

On June 25, 2003, the Federal Reserve targeted the lowest Federal Funds rate in the history of open market operations:  1.00%.  Not coincidentally, that's about the time that the mortgage market in the U.S. really heated up, as lenders began dropping rates on fixed rate and variable rate mortgages to historic lows.  The Fed Funds target rate stayed at 1.00% until June 30, 2004, when the Federal Reserve began increasing the target rate by 0.25% each meeting — and mortgage loan interest rates have been increasing steadily since then as well.

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