When the Fed Cuts Rates, Do Mortgage Rates Follow?
On September 18th, the Federal Reserve lowered the federal funds rate for the first time in two years, signaling that inflation is starting to let up. Prior to this date, mortgage rates eased slightly in anticipation of the reduction. Once it was officially announced, they decreased further.
However, less than a month later, rates began leveling out and even climbing. So, what gives?
Bottom line, the Fed does not set mortgage rates.
They decide to increase or lower the federal funds rate—which is the interest rate banks charge each other for overnight loans—and only influence mortgage rates.
The federal funds rate is a benchmark, a signal. It has a significant effect, however, a number of factors actually go into determining mortgage rates. It’s basically a very complex dance.
The Fed and the Federal Funds Rate
Formed in 1913, the Federal Reserve System is the central bank of the United States. A Board of Governors participates in its Federal Open Market Committee (FOMC), and it’s their responsibility to set and oversee the country’s monetary system to ensure financial stability and minimize risk.
They monitor any changes in the economy (e.g. unemployment rates, GDP growth) regulate the money supply, and set interest rates. In fact, the FOMC meets eight times each year to decide whether or not to adjust the federal funds rate.
In the simplest terms, raising the rate makes borrowing more costly thus cooling an overheating economy or tempering inflation. Lowering the rate makes borrowing cheaper which stimulates the economy and encourages spending. The Covid-19 pandemic is a big example.
When Covid caused the economy to grind to a near halt in 2020, equally significant rate drops got it going in a hurry. It had a huge influence on mortgage rates which dropped and ignited the real estate market. Homes flew off the shelves faster than new listings could come on.
However, in real estate and many other industries, demand soon outpaced supply which caused prices of goods, services, and yes, even homes, to skyrocket—aka inflation. To slow things down, the Fed put on the brakes by increasing the federal funds rate.
The first of 11 rate hikes occurred in March of 2022 and ended in July of 2023. This move slowed buying and spending by increasing rates for everything from credit cards to mortgages.
Economic Factors that Affect Mortgage Rates
Beyond the federal funds rate, many other factors influence mortgage rates. Without giving you a crash course in economics, here’s what goes into determining them:
- Bonds – Mortgage bonds or mortgage backed securities are bundled mortgages sold to investors. When prices go up or down, rates typically follow.
- U.S. Treasury Bonds – The 10-Year Treasury note (and its yields) is a big one as it reflects investor sentiment and confidence in the economy.
- Constant Maturity Treasury (CMT) Rates – Primarily affecting adjustable-rate mortgages (ARMs), lenders calculate a mix of U.S. Treasury securities and average yields.
- Inflation and the Economy – When unemployment is low, the economy is doing well, and inflation is low, rates tend to go up, though lender competition keeps things in check.
- Global/Political Events – From the stock market to bonds to mortgage rates, these can all be affected by factors such as war on the other side of the globe and our U.S. elections.
Again, these are rather simple explanations. The key takeaway here is that the federal funds rate is just one component that goes into determining mortgage rates. If you’re thinking about buying a home, it might also feel like it’s completely out of your hands.
However, your own financial standing is another major consideration. With everything in order, you can even qualify for a mortgage with rates well below the average.
Your Finances, Your Mortgage Rate
While the federal rate cut can have a positive effect on mortgage rates, it's important to keep in mind several other personal considerations that influence your final rate as a borrower:
- Credit Score: Lenders offer their most competitive rates to borrowers with strong credit histories. Even with a federal rate decrease, individuals with poor credit may not see the full benefit of lower rates. So, check and repair your credit. Investigate and fix anything suspicious or inconsistent. To reduce your overall debt, determine what items you can pay off quickly and keep revolving credit balances low.
- Debt-to-Income Ratio: DTI is monthly debt obligations divided by gross income. This can include credit cards, student/personal loans, or child support payments. It doesn’t account for other expenses like a cell phone bill, entertainment, or groceries. Mortgage and home costs should be no more than 28% of your gross income, and nnce everything is calculated, your total DTI should be no more than 36%.
- Down Payment and Loan Amount: Homebuyers who can pay more upfront are seen as less risky by lenders and simply need to borrow less money. All of this usually leads to a better interest rate. If you cannot swing 20% down, you will likely be required to pay for private mortgage insurance (PMI) to compensate lenders for the added risk of a larger loan. How much you pay will depend on your credit score, loan-to-value ratio, and loan type. Talk over your options with both your real estate agent and mortgage broker.
Even with pristine credit and minimal debt, securing a mortgage at the best possible rate can be stressful. To streamline the process, gather documentation as early as possible. Pull records of bank accounts, income tax returns, car loans, credit cards, any other debts, plus assets such as investments, other properties and your 401k.
Keep in mind that even after you’re approved, most lenders will continue to track your finances and credit until closing. Continue paying your current mortgage or rent, as well as bills and credit cards. Don’t close accounts, apply for a new credit card, change jobs, make major purchases, or switch banks. Maintain the status quo until all paperwork is signed.
So, Is Now a Good Time to Buy—or Sell?
Now that you know how many components go into setting mortgage rates, you can see why they tend to fluctuate. So, should you go ahead with your home search? If you’re looking to sell your home, will you be able to find a buyer? These are great questions.
Mortgage rates aside, buyers should first take a look at the real estate market. Currently, buyers have more homes to choose from and more time to search for the right one. They can perform inspections, complete their due diligence, and potentially negotiate the price and terms. When rates were low and competition was high, this was not possible.
Other indicators that now is a good time to buy a home:
- You've found the right house and can afford it comfortably—that includes having about six months of money saved in an emergency fund.
- You plan on staying in the home for a long time. Historically, equity is gained slowly and steadily with national appreciation values averaging around 3.5-3.8% annually. That won’t be the case every year, but over the lifetime of your loan, you will gain equity.
- You understand that rates change and you can potentially refinance to a lower mortgage rate down the road.
If you own a home and are considering selling, this might not sound all that favorable. You may wonder if you should wait until spring when the market tends to be busier. However, the Fed has two more meetings on the books for 2024, and more cuts are expected. This could drive quite a bit of buyer activity throughout the fall and winter months.
In addition, keep in mind that buyers have had two years to adjust their expectations and budgets to fit with higher rates and home prices. Those who remain on the hunt are serious buyers, likely qualified and highly focused on getting into the right home.
During the winter, especially over the holidays, there are also typically fewer listings to contend with, allowing your home to stand out. Between paid holidays and vacation time, buyers have more free time to house hunt as well. You can likely book more showings and get a quick offer.
The key is to work closely with an experienced real estate agent. At PorchLight, our agents are keen analysts who will help you sell for top dollar. They’re also backed by a team that will provide you with home cleaning, staging, photography, and a full suite of marketing services.
The Takeaway
Ultimately, a lot goes into determining today’s mortgage rates. The Fed’s decrease was certainly one indicator that things are finally coming back down to earth. However, your credit score and finances play a big role as well. And that’s something you have complete control over.
And if your decision to buy or sell has been hinging on rates, it’s time to take charge and achieve your goals. Feel free to reach out to our team—we’re here to help you make smart decisions.