Mortgage rates fluctuate along with other interest rates. Interest rates are affected chiefly by inflation and the market for debt (notes, bills, and bonds, among other instruments). With inflation extremely low in recent years, we've enjoyed low interest rates. But if signs of inflation begin to pop up, the Federal Reserve ("the Fed"), currently headed by Alan Greenspan, may hike up short-term interest rates via an adjustment in the rate of interest on "federal funds." The "fed funds" rate is the interest rate a bank can charge another bank for use of its excess money. The Fed can also change the "discount rate," or the rate paid by a bank to borrow short-term funds from the Fed. The prime rate and other rates (such as mortgage rates) are based primarily on these two interest rates.
The Fed raises these interest rates when the economy appears to be growing too briskly, since brisk growth can spur inflation. When the economy is sluggish, the Fed might cut these rates to give American enterprise a boost. Lower rates give companies and people (including homebuyers) an incentive to borrow money or refinance existing loans at lower rates. However, remember that the money markets themselves (basic supply and demand for money at each price point) exert the biggest influence over interest rates, though the Fed is a big influence on market expectations.
Learn more about Alan Greenspan and the Fed. (Did you know Greenspan is a mathematician and Juilliard-trained musician, married to news correspondent Andrea Mitchell?)
