Your frequently asked questions about the Federal Reserve answered

Mortgage rates, home prices and buyer demand could shift because the Federal Reserve cut its benchmark interest rate by a quarter percentage point on Wednesday, its first reduction in nine months, and signaled more reductions to come.

The central bank’s policy committee met over two days amid a swirl of mixed economic signals, political pressure and renewed scrutiny of its independence — implications that could stretch far beyond Wall Street.

So, what is the Federal Reserve, and how do its decisions affect the housing market?

The Federal Reserve, established in 1913, is the U.S. central bank responsible for maintaining financial stability and guiding monetary policy. It consists of the Board of Governors and 12 regional banks, which work together to manage interest rates, supervise financial institutions, safeguard payment systems, and promote consumer protection and community development.

Seven members, known as “governors,” run the board, serving 14-year terms. The president of the United States nominates them, and the Senate votes on their confirmation. Among these members, the board includes a chair and vice chair, who may be appointed for one or more four-year leadership terms.

This week, the Senate confirmed Trump’s third appointee to the seven-member Board of Governors. Stephen Miran was sworn in just in time for the September meeting. Miran will finish Fed governor Adriana Kugler’s term, which ends in January. Kugler stepped down last month.

Congress mandates the Fed to accomplish two goals:

• Promote maximum employment, which means reaching the highest level of employment, or lowest level of unemployment, that the economy can hold up while maintaining a stable inflation rate.
• Keep prices steady for goods and services.

The Fed adjusts short-term interest rates and shapes financial conditions to help guide the economy toward two big priorities: maintaining stable prices and making sure people who want jobs can find one.

The Fed’s monetary policy decisions ripple through everyone’s financial life. They can influence the way consumers spend money — on groceries, rent and car payments — but also how businesses decide what to produce, how many workers to hire and where to invest.

The Fed is designed to work as an independent entity within the government. In practice, the central bank can set interest rates without Congress or the White House's interference, even if government officials are unhappy with its decisions and publicly voice that.

Congress technically has the power to change the law, but no bill has gained traction to alter the Fed’s mandate. That’s largely because lawmakers understand the repercussions if they or the president had direct influence on interest rate decisions: It would likely flare up inflation.

This is the interest rate the government sets for one bank to charge another bank for short-term loans, typically overnight. It’s normally a target rate range. Banks negotiate with one another the specific rate within the target range that the Federal Reserve sets.

The Federal Reserve has a Federal Open Market Committee, also known as the FOMC, that sets monetary policy. It has 12 voting members: The seven governors in Washington, the president of the New York Fed, and four other regional Fed presidents, who rotate each year. The rest of the regional Fed presidents attend the meetings but don’t vote.

The FOMC meets at least eight times per year to set the target range banks will use to borrow from one another. At these meetings, the FOMC decides whether to raise, lower or hold interest rates the same.

The Fed adjusts interest rates to help guide the U.S. economy and influence what consumers pay for everyday essentials. When prices for groceries, gas, housing and other necessities go up, that’s inflation, and the Fed uses rate changes to influence economic activity, which can affect costs.

By raising interest rates, the Fed is making borrowing more expensive. This would result in the economy slowing down, and inflation would likely ease.

If the economy needs a lift, the Fed decreases interest rates.

And if the economic outlook is uncertain, the Fed will often stand pat.

A basis point is a fancy way of saying 1/100th of 1% or 0.01%. And in decimal form, it comes out to be 0.0001 (0.01/100).

If the Federal Reserve cuts by 25 basis points, that means the rate would be lowered by one-quarter of a percentage point, or 0.25%. This might sound small, but it's a meaningful adjustment.

The FOMC tends to adjust the federal funds target gradually, according to Christopher L. Hanes, a professor of economics at Binghamton University.

For Americans, that kind of rate cut could eventually mean lower borrowing costs on mortgages, auto loans, and credit cards.

If the Federal Reserve cuts by 50 basis points, that means it’s lowering its benchmark interest rate by half a percentage point or 0.50%.

That’s a bold move.

“It is typically deployed when the Fed perceives a more urgent need to support growth or counteract tightening financial conditions,” Parker Ross, global chief economist at Arch Mortgage, told Homes.com.

Another reason for such action? The Fed may strongly believe that the unemployment rate could sharply rise, without a substantial rate cut, according to Hanes.

Bottom line: It’s the Fed’s way of signaling “the economy requires a significant policy shift,” said Ross.

When the Fed cuts interest rates during a period of tight monetary policy, it’s likely more about a recalibration than a crisis move. It often signals that inflation is moving closer to the Fed’s target of 2% over the long run and that the balance of risks in the economy has changed.

For instance, Fed Chairman Jerome Powell signaled in late August that the economic trajectory was evolving in a direction that allowed for the central bank to adjust its policy stance. Rather than waiting for inflation to reach its target, the Fed is now willing to act if signs of a softening labor market begin to emerge.

“In that sense, a cut is less an admission of weakness and more a signal that conditions allow policymakers to return rates to a more neutral stance — neither stimulative nor restrictive,” Ross said. “Given the current backdrop, where interest rates are already highly restrictive, rate cuts reflect a normalization of policy rather than an effort to actively stimulate the economy.”

The Federal Reserve gains critical insight from the labor market as it balances its dual mandate: maximum employment and price stability. When job creation is strong, it can fuel consumer spending and push inflation higher. In contrast, a slower labor market could ease demand and reduce inflation risk, prompting the Fed to cut interest rates, Ross said.

Over the past few months, the labor market has deteriorated. The Bureau of Labor Statistics reported on Tuesday that it lowered its previously reported new payroll gains by 911,000 in the 12 months through March. This means the U.S. created only 847,000 jobs during that period, not the 1.8 million positions it had originally reported. Meanwhile, the U.S. just added 22,000 jobs in August and the unemployment rate touched the highest level since 2021.

The Fed doesn’t stick to a fixed plan; it adjusts its decisions based on the latest economic data.

“The Fed attempts to act on data in a deliberative, nonpartisan way. The FOMC makes each decision through an independent vote, weighing risks to both inflation and jobs,” Dan Lindberg, principal economist at Applied Economic Insight LLC, said in a statement.

Last September, for example, the Fed lowered the target Federal Funds rate by 50 basis points due to signs of a cooling labor market and easing inflation. A second reduction of 25 basis points followed shortly after the presidential election. There was another 25-basis-point cut in December, reflecting a sluggish process in bringing down inflation.

Still, consumers are paying more for goods such as cars, clothes and essentials like food and housing. Inflation continues to heat up for the fourth straight month, returning to the highest level since the start of the year. Meanwhile, employers have pulled back, as they navigate heightened uncertainty, costlier foreign goods, and a tighter labor supply amid immigration policies.

This cut “should be viewed as part of a broader normalization after a prolonged period of restrictive settings,” Ross said. “They do not reflect panic about current conditions but rather the judgment that inflation has eased sufficiently to permit a gradual recalibration, aligning policy more closely with the evolving balance of risks.”

The Fed lowering its target interest rate affects a wide range of borrowing costs, from credit cards to mortgages, but it primarily influences short-term interest rates. Long-term rates, like those of five- or 10-year loans, are shaped by expectations around future policy, inflation and market demand.

Cutting rates too soon could backfire. Lindberg warns that it could cause “a resurgence in inflation, driving prices up. This is especially risky considering increased tariffs on foreign goods. If domestic demand is stronger than it looks, or if tariff-driven price pressures persist, cutting too soon could reignite inflation.”

According to Hanes, if the Fed misjudges the labor market, and employment is not as weak as it thought, the economy could overheat, spurring inflation instead of cooling it.

The Fed’s hesitation isn’t about being unsure, but about navigating a complicated economic landscape.

Inflation remains stubbornly high, partly due to tariffs and other cost pressures, while signs of weakness are emerging in the job market.

“This tension, between the need to maintain restrictive rates to contain inflation and the need to lower rates to support employment, has underpinned the Fed’s reluctance to move quickly,” Ross said.

The way Lindberg described it, the Fed acts “like a detective,” sifting through economic clues to assess whether conditions call for tightening or easing monetary policy. The central bank looks at a wide range of indicators like inflation trends, labor market signals (unemployment, wage growth, economic growth, the gross domestic product and consumer spending), inflation expectations, and the balance between inflation and employment to make its rate decisions.

Ross explained that the Fed looks at three key factors before making decisions:

• Inflation — Will consumer price increases for goods and services consistently trend lower?  
  
• Employment — Is the labor market growing or slowing in a healthy way, without triggering massive layoffs?  
  
• Financial markets behavior — Are things stable, or is there turbulence that to some degree could affect short- and long-term interest rates, consumer prices, credit availability, and much more?  

Premature rate cuts can stimulate demand while inflationary pressures, especially from tariffs, remain. If price increases “feed into wage demands or expectations,” that could trigger a new wave of inflation, according to Lindberg.

In turn, the Federal Reserve’s credibility would be at risk. If inflation overheats, the Fed may need to reverse course with aggressive tightening measures, which could destabilize markets and erode public confidence. This would also create uncertainty, making it more difficult for businesses and consumers to plan and invest.

Delaying rate cuts can lead to a sharper economic slowdown, increasing the risk of higher unemployment, Lindberg said.

This could also reduce the effectiveness of monetary policy in cushioning downturns, causing a slower recovery.

The Federal Reserve doesn’t outright set mortgage rates, but its actions influence the rates lenders offer prospective homeowners. Even when the Fed holds its benchmark rate steady, mortgage rates can still fluctuate due to market dynamics.

In anticipation of the Fed's interest rate cut, mortgage rates have dropped 15 basis points, reaching their lowest average in over a year, according to mortgage giant Freddie Mac. However, lenders remain cautious about whether a September rate cut will keep mortgage rates down.

Research from the Federal Reserve Bank of San Francisco found that home prices respond to unexpected changes in monetary policy within weeks rather than years. Changes to the federal funds rate have less of an effect than the central bank’s forward guidance, and sales of Treasury securities affect long-term interest rates. These shifts affect mortgage rates and when mortgage rates rise, the total cost to homeownership climbs, often causing sellers to lower their prices.

More on this topic

• Is it a good time to refinance your adjustable-rate mortgage?
• Understanding the mortgage process from preapproval to closing
• How can sidelined homebuyers take advantage of lower mortgage rates?
• Fed makes first interest rate cut in nine months. Two more anticipated before year's end.