How the Fed's Interest Rate Cut Could Impact Mortgage Rates

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On Wednesday, the Federal Reserve announced its third interest rate cut of 2024. When the Fed pivoted to cutting interest rates this fall because of cooler inflation, many prospective homebuyers thought mortgage rates would immediately come down.

But mortgage rates, driven by investor expectations and the bond market, are always volatile. The Fed doesn't directly set the rates on home loans, even though its decisions on monetary policy help guide banks and lenders across the country.

The central bank's Summary of Economic Projections, which outlines the outlook for interest rates over the coming months, indicates that the Fed still plans to cut rates next year. However, given stubborn inflation readings and the expectation that price pressures will remain elevated, there will likely be only two 0.25% rate reductions in 2025.

In his postmeeting remarks Wednesday, Fed Chair Jerome Powell said, "We still see ourselves on track to cut, but it will depend on the data."

Unfortunately for prospective homebuyers, that forecast is likely to keep upward pressure on bond yields and mortgage rates in the near term, said Nicole Rueth, SVP of the Rueth Team Powered by Movement Mortgage.

Here's what to know about how the government's interest rate policy affects mortgage rates.

What does the Federal Reserve do?

The Fed was established by the 1913 Federal Reserve Act to set and oversee U.S. monetary policy to stabilize the economy. Consisting of 12 regional banks and 24 branches, it is run by a board of governors who are voting members of the Federal Open Market Committee. The FOMC sets the benchmark interest rate at which banks borrow and lend their money.

In an inflationary environment, the Fed uses interest rate hikes to slow economic growth and make borrowing money more cost-prohibitive. Banks typically pass along rate hikes to consumers in the form of higher interest rates for longer-term loans, including home loans. When the economy is in a slump or downturn, the Fed reduces interest rates to stimulate consumer spending and propel growth.

How does the Fed impact mortgage interest rates?

The Fed doesn't directly set mortgage rates, but it influences them by making changes to the federal funds rate, the interest rate that banks charge one another for short-term loans. The Fed's decisions alter the price of credit, which has a domino effect on mortgage rates and the broader housing market over the long term.

"When the Fed raises interest rates to slow the economy, rate-sensitive sectors like tech, finance and housing typically feel the impact first," said Alex Thomas, senior research analyst at John Burns Research and Consulting.

It's important to monitor the Fed's actions. Its decisions affect your money in multiple ways, including the annual percentage rate on your credit cards, the yield on your savings accounts and even your stock market portfolio.

What is the outlook for Fed rate cuts and mortgage rates?

If the Fed implements additional rate cuts in 2025, mortgage rates should gradually decline. However, the timing of those cuts, as well as the economic data we get between each policy meeting, will determine how quickly (and how far) mortgage rates can fall.

The next administration's economic policies are likely to propel the Fed to step back from easing interest rates. President-elect Donald Trump's proposals for tax cuts and tariffs could stimulate demand, increase deficits and push inflation back up, which would give the Fed an incentive to keep borrowing rates higher for longer.

Powell has said it's too early to say how Trump's economic agenda and a Republican-led Congress might alter the central bank's approach to interest rate adjustments, noting only the need to move cautiously. But at its first gathering of 2025 on Jan. 28-29, experts say, the central bank is likely to forgo a rate cut, delaying further policy changes until at least March.

Though much is still uncertain, it'll be difficult for 30-year fixed mortgage rates to drop below 6% without weaker economic data and ongoing Fed cuts.

What factors affect mortgage rates?

Mortgage rates move around for many of the same reasons home prices do: supply, demand, inflation and even the employment rate. Additionally, the individual mortgage rate you qualify for is determined by personal factors, such as your credit score and loan amount.

Economic factors that impact mortgage rates

Policy changes from the Fed: When the Fed adjusts the federal funds rate, it spills over into many aspects of the economy, including mortgage rates. The federal funds rate affects how much it costs banks to borrow money, which in turn affects what banks charge consumers to make a profit.

Inflation: Generally, when inflation is high, mortgage rates tend to be high. Because inflation chips away at purchasing power, lenders set higher interest rates on loans to make up for that loss and ensure a profit.

Supply and demand: When demand for mortgages is high, lenders tend to raise interest rates. The reason is because lenders have only so much capital to lend out in the form of home loans. Conversely, when demand for mortgages is low, lenders slash interest rates to attract borrowers.

The bond market: Mortgage lenders peg fixed interest rates, like fixed-rate mortgages, to bond rates. Mortgage bonds, also called mortgage-backed securities, are bundles of mortgages sold to investors and are closely tied to the 10-year Treasury. When bond interest rates are high, the bond has less value on the market where investors buy and sell securities, causing mortgage interest rates to go up.

Other economic indicators: Employment patterns and other aspects of the economy that affect investor confidence and consumer spending and borrowing also influence mortgage rates. For example, a strong jobs report and a robust economy could indicate greater demand for housing, which can put upward pressure on mortgage rates. When the economy slows and unemployment is high, mortgage rates tend to be lower.

Personal factors that impact mortgage rates

The specific factors that determine your particular mortgage interest rate include:

Your credit score.
The home's location.
The home's price.
Your down payment.
The loan amount.
The loan type and term.
The type of interest rate.

Is now a good time to shop for a mortgage?

Even though timing is everything in the mortgage market, you can't control what the Fed does.

You can get the best rates and terms available by making sure your financial profile is healthy while comparing terms and rates from multiple lenders.

Regardless of the economy, the most important thing when shopping for a mortgage is to make sure you can comfortably afford your monthly payments.

"Buying a home is the largest financial decision a person will make," said Kushi. If you've found a home that fits your lifestyle needs and budget, purchasing a home in today's housing market could be financially prudent, Kushi noted.

If you're priced out, it's better to wait. "Sitting on the sidelines may allow a potential buyer to continue to pay down their debt, build up their credit and save for the down payment and closing costs," she said.

The bottom line

When the Federal Reserve adjusts the benchmark interest rate, it indirectly affects mortgage rates. The Fed's rate cuts will help home loan rates improve, although it won't be dramatic or immediate. Mortgage rates will also respond to inflation, investor expectations and the broader economic outlook. Experts predict that mortgage rates should go down slowly over the next year.

If you're shopping for a mortgage, compare the rates and terms offered by banks and lenders. The more lenders you interview, the better your chances of securing a lower mortgage rate.