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The Federal Reserve cut federal funds rate last week for the first time in four years, raising borrowers’ hopes that the cut will trickle down to new mortgage and refinancing ratesThe Fed’s action ends 14 months of interest rate pauses that, along with inflation, unemployment and other factors have led to prolonged high borrowing costs.
Although the Fed does not directly set mortgage interest rates, her decisions can affect them. Mortgage rates often — but not always — fluctuate in line with the federal funds rate. Sometimes mortgage rates react before expected decisions. For example, mortgage rates fell about half a percentage point in July and August, perhaps in anticipation of the expected interest rate cut by the federal government.
Here’s what you need to know about how the Federal Reserve affects mortgage rates.
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To what extent do mortgage rates follow the Fed’s rate decisions?
Mortgage rates often move in the same direction as the federal funds rate. As Robert R. Johnson, a professor at the Heider College of Business at Creighton University, notes, “Directionally, mortgage rates follow the Fed’s moves very closely. In other words, you’re very unlikely to see an upward trend in mortgage rates when the Fed is easing, and you’re very unlikely to see a downward trend in mortgage rates when the Fed is tightening. I would argue that the Federal Reserve’s monetary policy is the single most important factor influencing mortgage rates.”
Mortgage rates are influenced by several factors
Federal Reserve decisions can affect mortgage rates, but they are also affected by inflation, the bond market, the unemployment rate, and the broader economy. In general, when the economy is growing, job growth and consumer spending are high, and mortgage rates tend to rise. The reverse is also true: When the economy tightens, there tend to be more unemployment, spending declines, and mortgage rates can fall.
“There are many factors that cause mortgage rates to rise and fall,” says Brian Shahwan, vice president and mortgage broker at William Raveis Mortgage. “The most important factors to watch are the weekly economic reports. As inflation cools and the economy stabilizes, mortgage rates will fall. If the weekly economic data shows a strong economy, mortgage rates will start to rise again.”
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Have expected interest rate changes been taken into account when calculating mortgage rates?
Yes, mortgage rates often respond to anticipated changes in the Federal Reserve’s interest rates before they happen. For example, if the Fed expects to raise interest rates, lenders may raise their rates ahead of time to avoid paying higher borrowing costs later. Conversely, if lenders expect the Fed to lower interest rates, they may lower their rates ahead of time to get ahead of the competition and encourage borrowers to record before others lower their rates.
“As we have seen recently, markets can be sensitive to the forecasts announced at each Fed meeting,” Shahwan says. “When mortgage lenders ‘price in’ potential Fed rate hikes or cuts, they adjust mortgage rates based on the Fed’s forecast. For example, Fed Chairman [Jerome] Powell announced in August that it was time for a cut in September. Mortgage banks in turn began cutting rates, purely on the rhetoric that inflation was cooling.”
Should home buyers buy now or wait?
Choose whether you buy now or wait is a personal decision that depends on your finances, unique financial situation, lifestyle preferences and long-term goals. If you have found your dream home and can comfortably afford it the monthly mortgage paymentproperty taxes and other costs of home ownership, it may make sense to buy now. As many real estate professionals often advise, “Marry the house, date the price.” In other words, focus on finding your dream home. You can always refinance later if rates drop significantly.
On the other hand, if interest rates continue to fall, waiting to buy could result in a lower mortgage interest rateOf course, timing the market has inherent risks. For example, falling mortgage rates can increase competition for publicly traded homes and push up house prices.
The heart of the matter
No one can predict with certainty what the Fed will do with interest rates, including the agency itself. During the Fed’s press conference during September Commission MeetingPowell acknowledged that there is no predetermined course.
Still, Powell expects the Fed to close the year at 4.40% and 3.40% in 2025. With rates currently between 4.75% and 5.00%, the agency would need to cut rates again this year and next to meet those targets. If mortgage rates follow the Fed’s lead, either in anticipation of a rate cut or afterward, borrowers could benefit from even lower interest rates in the near future.
