How the U.S. Fed’s rate cut impacts mortgage rates

A development of new homes in Eagleville, Pa., is shown on April 28, 2023. (AP Photo/Matt Rourke, File)

LOS ANGELES — Hoping that mortgage rates will keep dropping following the Federal Reserve’s first rate cut since last year? Don’t bank on it.

As expected, the central bank delivered a quarter-point cut Wednesday and projected it would lower its benchmark rate twice more this year, reflecting growing concern over the U.S. job market.

Here’s a look at factors that determine mortgage rates and what the Fed’s latest move means for the housing market:

How rate cuts affect mortgage rates

Mortgage rates have been mostly falling since late July on expectations of a Fed rate cut. The average rate on a 30-year mortgage was at 6.35 per cent last week, its lowest level in nearly a year, according to mortgage buyer Freddie Mac.

A similar pullback in mortgage rates happened around this time last year in the weeks leading up to the Fed’s first rate cut in more than four years. Back then, the average rate on a 30-year mortgage got down to a 2-year low of 6.08 per cent one week after the central bank cut rates.

But it hasn’t come close to that since.

Mortgage rates didn’t keep falling last year, even as the Fed cut its main rate two more times. Instead, mortgage rates rose and kept climbing until the average rate on a 30-year home loan reached just over 7% by mid-January.

Like last year, the Fed’s rate cut doesn’t necessarily mean mortgage rates will keep declining, even as the central bank signals more cuts ahead.

“Rates could come down further, as the Fed has signaled the potential for two more rate cuts this year,” said Lisa Sturtevant, chief economist at Bright MLS. “However, there are still risks of a reversal in mortgage rates. Inflation heated up in August and if the September inflation report shows another bump in consumer prices, it’s possible we could see rates rise.”

How mortgage rates are set

The Fed doesn’t directly set mortgage rates. Instead, they’re influenced by several factors, from the Fed’s interest rate policy decisions to bond market investors’ expectations for the economy and inflation.

Mortgage rates generally follow the trajectory of the 10-year Treasury yield, which lenders use as a guide to pricing home loans.

That’s because mortgages are typically bundled into mortgage-backed securities that are sold to investors. To keep mortgage-backed securities attractive to investors, their yield — or annual return -- is adjusted to be competitive with the yield offered by the U.S. on its 10-year government bonds. When those bond yields rise, they tend to push up mortgage rates, and vice-versa.

The 10-year Treasury yield has been mostly easing since mid-July as growing signs that the job market has been weakening fueled expectations of a Fed rate cut this month.

Until now, the Fed had kept its main interest rate on hold this year because it was more worried about inflation potentially worsening due to the Trump administration’s tariffs than about the job market.

At the same time, inflation has so far refused to go back below the Fed’s two per cent target.

When the Fed cuts rates that can give the job market and overall economy a boost, but it can also fuel inflation. That, in turn, could push up mortgage rates.

“It’s not just about what the Fed is doing today, it’s about what they’re expected to do in the future, and that’s determined by things like economic growth, what’s going to happen in the labor market and what do we think inflation is going to be like over the next year or so,” said Danielle Hale, chief economist at Realtor.com.

What to expect for mortgage rates

“If the Fed keeps lowering rates, it doesn’t necessarily mean mortgages will go down,” said Stephen Kates, financial analyst at Bankrate. “It means that they probably could go down more, and they may trend in that direction, even if they don’t move in lockstep.”

Ahead of the Fed’s rate cut, the futures market had priced in expectations that the central bank would cut its key interest rate at upcoming policy meetings this year and into 2026. But the Fed’s latest projections show a less aggressive path of rate cuts than the market has been expecting.

“This ongoing gap between market and Fed expectations means that some risk of upward pressure on mortgage rates remains,” said Hale, adding that the decline in mortgage rates “is likely to continue at least through this week.”

Hale recently forecast that the average rate on a 30-year mortgage will be between 6.3 per cent and 6.4 per cent by the end of this year. That’s in line with recent projections by other economists who also don’t expect the average rate to drop below six per cent this year.

Overall impact on the housing market

The late-summer pullback in mortgage rates has been a welcome trend for the housing market, which has been in a slump since 2022, when mortgage rates began climbing from historic lows. Sales of previously occupied U.S. homes sank last year to their lowest level in nearly 30 years and have remained sluggish so far this year.

While lower rates give home shoppers more purchasing power, mortgage rates remain too high for many Americans to afford to buy a home. That’s mostly because home prices, while rising more slowly than in years past, are still up by roughly 50 per cent nationally since the start of this decade.

“While lower rates will bring some buyers and sellers into the market, today’s cut will not be enough to break up the housing market logjam,” said Sturtevant. “We will need to see further drops in mortgage rates and much slower home price growth, or even home price declines, to make a dent in affordability.”

If mortgage rates continue to ease, home shoppers will benefit from more affordable financing. But lower mortgage rates could also bring in more buyers, making the market more competitive at a time when sellers across the country are having a tougher time driving a hard bargain.

The options for home shoppers and buyers

Predicting when mortgage rates will decline and by how much is daunting because so many variables can influence their trajectory from one week to the next.

Home shoppers who can afford to buy at current rates may be better off buying now if they find a property that fits their needs, rather than attempt to time the market, said Kates.

Many homeowners looking to refinance have already seized on the decline in rates, sending applications for refinance loans sharply higher in recent weeks.

One rule of thumb to consider when refinancing is whether you can reduce your current rate by at least one percentage point, which helps blunt the impact of refinancing fees.

Alex Veiga, The Associated Press