When you see all the excitement surrounding the likelihood of a Federal Reserve rate cut by the end of this year, you might think Christmas has come early.
People attach almost magical powers to the Fed and its interest rate cuts. Supposedly, rate cuts will benefit the housing market, homeowners and would-be homebuyers.
It’s true that rate cuts have some benefits. But Fed Chair Jerome Powell is no Wizard of Oz, standing behind a curtain and pulling the levers that control all aspects of the economy. In fact, Fed rate cuts don’t even affect all interest rates.
As a reality check, here is the truth behind several myths about how a Fed rate cut is likely to impact mortgage rates and the housing market.
[READ: Compare Current Mortgage Rates]
Myth #1: The Fed Controls Mortgage Rates
The federal funds rate and mortgage rates are both interest rates. Beyond that, they are very different.
“While the Fed’s rate decisions primarily influence short-term interest rates, mortgage rates are more closely tied to long-term bond yields,” says Yosef Adde, owner of real estate site I BUY LA.
This is important, because near-term and long-term outlooks for the economy can differ. This can cause short-term and long-term interest rates to behave differently.
There’s a fundamental difference in how the federal funds rate and mortgage rates are set.
The Fed directly controls the federal funds rate. Mortgage rates, on the other hand, are determined by lenders making independent decisions based on inflation, economic growth, market demand and competitive forces.
Therefore, mortgage rates often move in responses to different influences and motivations than the federal funds rate.
Myth #2: Fed Rates and Mortgage Rates Always Move in the Same Direction
While the Fed does not set mortgage rates, mortgage lenders are concerned with some of the same economic forces the Fed watches. So, both rates may move in the same direction — but not always.
While the Fed and mortgage lenders are both concerned with inflation, the Fed balances this concern with trying to keep the job market strong. In contrast, mortgage lenders are more worried about inflation eroding the value of the interest and principal payments they’ll receive in the future.
“When inflation goes up, lenders usually raise mortgage rates to make sure they get a good return on their loans,” explains Eric Bramlett, owner of Bramlett Residential Real Estate. “So, even if the Fed cuts rates, mortgage rates might not go down — they could even go up.”
History supports what Bramlett says. The chart below shows the past 20 Fed rate changes compared to how mortgage rates changed at those same times. The Fed rate changes are shown in blue, and the mortgage rate changes are in red.https://docs.google.com/spreadsheets/d/1lLhLgxvXOtSeYJj_ZOE9j-JlTKlOmxqgBsxBC4Gusq4/edit?usp=sharing
Sources: US News & World Report analysis of Federal Reserve and Freddie Mac data
Since Fed changes occur on specific dates while mortgage rates can change every day, the chart measures changes in mortgage rates over a period covering one month before to one month after the Fed rate change. That captures the way mortgage rates may both anticipate and react to a Fed rate change.
As you can see from the difference in movements between the red and blue lines, Fed rates and mortgage rates are hardly in lockstep. In fact, they often dance to different drummers.
Out of the past 20 Fed rate changes:
— Mortgage rates have moved in the opposite direction eight times.
— They’ve moved in the same direction seven times, but with a difference of at least 25 basis points. (25 basis points = ¼ of 1%, or .25%.)
— There have been only five times that both rates moved in the same direction and within 25 basis points of each other.
Myth #3: Lower Mortgage Rates Will Jump-Start the Housing Market
The housing market has been sluggish lately, with existing home sales down slightly over the past year. In July, pending home sales dipped to their lowest level on record, based on data that goes back to 2001.
People who blame high mortgage rates for this assume a drop in those rates will revive home sales. However, Bramlett cautions “Even if mortgage rates go down, it doesn’t mean the housing market will suddenly become super busy.”
Adde agrees, pointing out that “several factors could still constrain housing market activity.” He cites inventory shortages, high home prices and stricter lending standards.
Myth #4: Mortgage Rates Are Currently High
Speaking of high mortgage rates — are they really that high?
After seeing mortgage rates rise by nearly 3 percentage points over the past five years, it would be natural for someone to call today’s mortgage rates “high.” However, a longer-term view paints a different picture.
Over the past 50 years, 30-year mortgage rates have averaged 7.71%. That’s well over a full percentage point higher than the current rate of 6.46% (as of late August 2024).
That might come as a surprise to anyone who got used to the 3% and 4% mortgage rates that were common from 2012 to 2022. However, from a historical perspective, that decade was very unusual. By comparison, today’s rates are fairly normal — in fact, a little below normal.
Of course, history doesn’t repeat itself in a precise way. However, it does suggest that if rates “get back to normal” it won’t mean they’ll get back down to 3%.
[SEE: Current Jumbo Mortgage Rates]
Myth #5: A Drop In Mortgage Rates Would Benefit People Who Have a Mortgage
According to the latest Household Debt and Credit Report from the Federal Reserve Bank of New York, consumers are laden with $17.8 trillion in debt. The vast majority of that is $12.5 trillion in mortgage debt.
A common assumption about rate cuts is that they will provide timely relief for households struggling with high debt burdens. However, since most of that debt is mortgages, a drop in mortgage rates would have limited impact.
After all, most mortgages have fixed rates. That means even if rates drop, current homeowners won’t automatically benefit. Those homeowners are locked into their existing mortgage rates. Only if mortgage rates experience a large, sustained decline will some homeowners be able to benefit by refinancing.
Myth #6: A Drop in Mortgage Rates Would Benefit all Would-Be Home Buyers
While current homeowners won’t necessarily benefit from a drop in mortgage rates, it would at least help would-be homebuyers, wouldn’t it?
This is only true of some homebuyers. Late payments have been rising for all major forms of consumer credit. As a result, lending standards are tightening, and those whose credit scores have suffered may not be offered lower mortgage rates.
There is a positive side to this. There are things homebuyers can do to make themselves more attractive to lenders. As Adde says, “Beyond waiting for general rate drops, buyers can take proactive steps to secure better mortgage rates.”
Examples of things Adde and Bramlett both recommended borrowers do to get better rates include:
— Work on your credit score.
— Save for a bigger down payment.
— Shop aggressively, because rates can vary significantly among lenders.
In short, your mortgage rate won’t necessarily go down with a Fed rate cut. But if you play your cards right, it might go down without one.
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No, Your Mortgage Rate Won?t Go Down With the Fed Rate Cut ? Debunking the Myths originally appeared on usnews.com
