Could a Fed Mortgage Rate Cut Lead to Rate Cuts?

If you’re considering buying a home or refinancing your mortgage, it’s helpful to know how mortgages are affected by the federal funds rate, especially with an interest rate cut expected at the September meeting next week. First, the Federal Reserve, or “the Fed,” is the central bank of the United States. Its job is to manage the money supply and the cost of credit so that the U.S. economy can thrive. It also sets the federal funds rate, which is the interest rate that banks charge each other for short-term loans, which directly affects the price consumers pay when they borrow money.

The Fed also influences mortgage rates, but does not set them. Instead, mortgage rates are affected by factors such as inflation, job growth, whether the economy is slowing or growing, etc. The Federal Reserve’s monetary policy is also a factor.

The Federal Open Market Committee (FOMC) said at its July 2024 meeting that while inflation has declined over the past year, it still remains somewhat elevated. In response, the Fed kept the federal funds rate unchanged in a range of 5.25% to 5.50%, a 23-year high. The central bank also left open the possibility of at least one rate cut this year, which many economists expect to come at next week’s Fed policy-setting meeting, earlier than expected. Depending on the outcome, that could mean relief for overinflated mortgage rates.

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The Federal Reserve and Mortgage Rates

While it’s hard to predict when an unexpected event will disrupt the market, it’s easier to make an educated guess about future mortgage rates by looking at the Fed’s current monetary policy. In a perfect world, the Fed would want to keep inflation around 2%. Inflation has been much higher than that for some time.

Adjustable-rate mortgages, such as home equity lines of credit (HELOCs) and adjustable-rate mortgages (ARMs), typically see their rates decline after a Fed rate cut. According to Freddie Mac, the average ARM rate in the first quarter of March 2024 ranged from 2.73% to 3.12%. The HELOC rate hovered around 4.3% to 4.4%, which is relatively stable.

Key points to consider:

The Federal Reserve sets the federal funds rate, which in turn influences other interest rates, such as mortgages.
Mortgage lenders consider many different factors when determining the interest rates they charge.
Although mortgage rates have started to fall, it will be a slow process. Average rates are unlikely to fall below 6% for some time.

What this means for home buyers

If you’re considering buying a home but can’t stomach mortgage rates that have risen to 8% this year (a mortgage below 3% was possible just a few years ago), a Fed rate cut can help you make a decision by helping you lower your monthly mortgage payments over time.

The difference between an 8% mortgage and a 3% mortgage on the same $400,000 loan over 30 years is nearly $1,000 per month. That said, you need to manage your expectations. It’s unlikely we’ll see the 3% mortgage rates that were available during the pandemic again anytime soon.

In addition to lowering your monthly payments, lower rates could convince more homeowners to sell. However, it can also mean more competition for the same home. Plus, increased demand and a lack of inventory could drive up home prices and potentially offset the benefits of lower rates.

The impact of a rate cut on fixed mortgage rates

Since the 10-year Treasury bond rate influences fixed-rate mortgage rates, not the federal funds rate, homeowners who currently have fixed-rate mortgages won’t see their interest rate change regardless of what the Fed does. However, borrowers who apply for a fixed-rate mortgage can lock in the new rate for the life of their loan, unless they refinance.

The impact of lower rates on adjustable rate mortgages

Fed rate cuts are most closely tied to adjustable-rate mortgages and HELOCs. That’s because the rate on an adjustable-rate mortgage adjusts roughly every six months. So if the Fed continues to cut rates, your monthly payment could gradually decrease. Conversely, your monthly payment could gradually increase if interest rates also rise.

Factors that affect mortgage rates

Mortgage rates are influenced by many factors, such as supply and demand, inflation, and the job market. Personal factors like your credit score, the amount borrowed, and your employment also play a role.

Economic factors:

Inflation. When inflation is high, mortgage rates tend to be high, although that’s not always the case. But because inflation often leads consumers to buy less, lenders make up for that loss by setting higher interest rates.
Supply and demand. When demand for housing is low, lenders tend to lower interest rates to attract borrowers. Conversely, when demand is high, lenders raise interest rates because they have only a limited amount of capital to lend in the form of mortgages.
Working data. When the jobs market remains supportive and inflation remains above the 2% target, the Fed has less incentive to cut rates.
Fed policy. Although the Fed doesn’t set mortgage rates, when it adjusts the federal funds rate, it affects mortgage rates and what banks must charge consumers to remain profitable.

The essentials

If the Fed cuts rates at its September meeting, as it is expected to do, mortgage rates could also fall. However, it is unclear how much rates will fall, as other economic conditions also play a role in how mortgage rates respond to the federal funds rate. Still, mortgage rates and the federal funds rate generally follow the same path. It is difficult to predict whether mortgage rates will follow the Fed’s actions or vice versa.