How Interest Rates Connect
Interest rates exist in an interconnected ecosystem. Understanding how they relate helps you make informed decisions about mortgages, loans, and investments.
The Interest Rate Hierarchy
Federal Funds Rate (4.75-5.00%)
The foundation. Set by Federal Reserve 8 times yearly. Rate banks charge each other for overnight loans. All other rates build from here.
Prime Rate (8.00%)
Fed Funds + 3%. Used for credit cards, HELOCs, some business loans. When Fed raises rates, prime follows immediately.
Treasury Yields (2.58% to 4.73%)
Market-driven rates on government bonds. 10-year Treasury is the key mortgage rate benchmark. When Treasury yields rise, mortgage rates follow.
Mortgage Rates (5.61-6.59%)
10-year Treasury + 1.5-2.5% spread for risk and profit. Your actual rate depends on credit score, down payment, and lender.
Federal Reserve's Role
The Federal Reserve (Fed) is America's central bank, responsible for monetary policy. Their primary tool is the federal funds rate, which they adjust to control inflation and support employment.
Current Fed Policy (October 2025)
- • Rate: 4.75-5.00% (down from 5.50% peak in July 2023)
- • Recent Action: 0.25% cut in September 2025
- • Outlook: Additional 0.50-0.75% cuts expected through Q1 2026
- • Inflation: Currently 2.8%, targeting 2.0%
- • Unemployment: 3.8%, near historic lows
When the Fed raises rates (like 2022-2023), borrowing costs increase across the economy to slow inflation. When they lower rates (like now), borrowing becomes cheaper to stimulate growth. Mortgage rates respond to Fed actions, but not dollar-for-dollar.
Treasury Yields Explained
Treasury securities are U.S. government bonds investors buy. The yield (return) on these bonds fluctuates based on investor demand and economic expectations. The 10-year Treasury yield is the single most important indicator for mortgage rates.
2-Year Treasury
4.58%
Short-term expectations
10-Year Treasury
4.23%
Mortgage benchmark
30-Year Treasury
4.73%
Long-term outlook
Notice the 10-year is lower than 2-year (inverted yield curve), signaling investors expect rate cuts ahead. When 10-year yields fall, mortgage rates typically follow within days.
How Rate Changes Affect Your Mortgage
New Mortgages
When Fed cuts rates → Treasury yields fall → Mortgage rates decline → Your payment decreases
Example: If current 6.25% rate falls to 5.75% on $500,000 loan, you save $153/month ($55,000 over 30 years)
Refinancing
Existing mortgage holders can refinance when rates drop 0.75-1.0% below current rate
Example: If you locked at 7.0% last year, today's 6.25% rate warrants refinancing consideration
ARM Adjustments
Adjustable-rate mortgages (ARMs) adjust based on index (usually SOFR) + margin
Example: If SOFR falls from 5.32% to 4.50%, your 5/1 ARM rate at next adjustment decreases 0.82%