Will mortgage rates drop if the Fed cuts rates this week? Probably. It’s complicated. A rate cut in the federal funds rate is predicted for Wednesday at the end of a two-day meeting of the Fed’s Federal Open Market Committee (FOMC), the policymaking body of the Federal Reserve System. There are other events coming this week, including some important economic and earnings reports. Wall Street is anticipating a cut of 0.25% to 0.5%, which would be the first rate cut since March 2020. That was when the COVID-19 pandemic erupted and basically stopped all activity, and the Fed moved to be sure the U.S. economy didn’t completely seize up. The last time the Fed raised the rate was in July 2023.
The term “federal funds rate” refers to the target interest rate range set by the FOMC, and is a key tool for controlling inflation. This target is the rate at which commercial banks borrow and lend their excess reserves to each other overnight. Investors monitor the federal funds rate because it has an impact on the stock market. The rate is also important to the general public, as it can influence short-term rates on consumer loans and credit cards.
It remains to be seen how much a rate cut by the Fed will affect mortgage rates. It’s a common belief that a “rate cut” refers to all interest rates, but the Federal Reserve doesn’t set mortgage rates. Mortgage rates are determined by the bond market and the activity on Wall Street. The graph above is proof: Over the last two decades, the fed funds rate and the average 30-year fixed mortgage rate have differed by more than 5%, and by as little as 0.5%. If the fed funds rate were truly linked to U.S. mortgage rates, the difference between the two rates would be linear or logarithmic, not jagged. That said, the Fed does influence today’s mortgage rates. After its scheduled meetings, the FOMC issues a press release to the public which highlights the group’s economic opinions and consensus. For rate shoppers, one of the key messages to listen for is what the Fed says about inflation. Inflation is the enemy of mortgage bonds and, in general, when inflation pressures are growing, mortgage rates are rising. The link between inflation rates and mortgage rates is direct, as homeowners in the early-1980s experienced. High inflation at the time led to the highest mortgage rates ever. 30-year mortgage rates went for over 17% during this period. If the Fed believes that inflation is under control, then mortgage rates will drop.
It may take a while for the full effect of the Fed’s rate cut and comments to show up in mortgage rates, but rates have already been trending lower in anticipation of a cut. Mortgage rates have fallen more than half a percent over the last six weeks, their lowest level since February 2023 and down significantly from last year’s peak of 7.79%. Freddie Mac’s Primary Mortgage Market Survey showed an average U.S. weekly 30 year rate of 6.2% on 9/12, with some local lenders quoting rates in the high 5%’s.
There is a good chance that mortgage rates will continue to trend down. Waiting to buy may be the best strategy if you want to lock in the lowest rate. However, as I mentioned in my last newsletter, rate drops are a double-edged sword. While lower rates would give homebuyers more purchasing power, they could also lead to more intense competition for homes on the market, driving record-high home prices even higher. The supply of homes is not likely to increase with a modest rate drop. Many homeowners locked in rates around 3%. Rates under 6% might be promising news for buyers, but they won’t be low enough to tempt existing homeowners to move. “It’s one of those things where you should be careful what you wish for,” said Greg McBride, the chief financial analyst at Bankrate. “A further drop in mortgage rates could bring a surge of demand that makes it tougher to actually buy a house.”
So what should you do? My advice is to buy now, before the market get even more frenzied and prices start to climb. Buy what you can afford with a payment you can live with. If rates come down you can always refinance, but don’t put yourself in a corner where rates must come down for you to be comfortable. If you are going to be paying cash for your purchase there really is no reason to wait. Lower rates won’t benefit you, and would actually make your purchase more competitive and more expensive. Give me a call if you would like to discuss your particular situation.