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The Federal Reserve’s Impact on Mortgage Rates

Mortgage rates should fall in 2024 with help from interest rate cuts by the Fed.

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What to know first

  • During its first monetary policy meeting of 2024, the Federal Reserve announced it would hold the federal funds rate steady at between 5.25% and 5.50% for a fourth consecutive time. 
  • The battle against inflation isn’t done quite yet: The central bank is hoping to reach its 2% target rate before it can start cutting interest rates.
  • Upcoming rate cuts should spur more activity in the mortgage market, though there won’t be any immediate or drastic drops in home loan rates.

Over the last two years, the Federal Reserve’s interest rate bumps have had an adverse effect on the housing market, helping to drive average mortgage rates into unaffordable territory. But economists say the Fed’s aggressive rate-hike policy is behind us. The Federal Open Market Committee has held the federal funds rate steady since last summer.

“Strong stock markets, solid labor conditions, resilient consumer [spending] and the appreciable recent decline in long-term interest rates are all supporting economic growth without the Fed needing to make any changes for now,” said Keith Gumbinger, vice president of mortgage site HSH.com. 

The Fed already outlined a plan to cut interest rates this year, yet those cuts won’t happen until inflation moves closer to the central bank’s 2% annual target. In its Jan. 31 statement, the FOMC said it still needs to “carefully assess incoming data, the evolving outlook, and the balance of risks” before making any adjustments.

So, what does all this mean for mortgage rates in 2024? Though future economic data will play a major role in determining the direction of home loan rates, experts agree that a pivot toward rate cuts is good news for homebuyers. Apart from some inherent volatility, mortgage rates should continue on a sustained downward trend toward 6% or even lower

Read more: Is it Worth Buying a Home in 2024? 10 Tips from Housing Market Experts

What does the Federal Reserve do?

The Fed was established by the 1913 Federal Reserve Act to set and oversee US monetary policy to stabilize the economy. Consisting of 12 regional banks and 24 branches, it’s 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 like today’s, the Fed uses interest rate hikes to make borrowing money more cost-prohibitive and slow economic growth. Banks typically pass along rate hikes to consumers in the form of higher interest rates for longer-term loans, including home loans. 

How does the federal funds rate impact mortgage interest rates? 

While the Federal Reserve doesn’t directly set mortgage rates, it influences them by making changes to the federal funds rate, the interest rate that banks charge each other 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. 

“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 keep an eye on what the Fed does: Its decisions can 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 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 the rates on mortgage loans

  • 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.
  • 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. 
  • 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 in order 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 

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

Will mortgage rates go down if the Fed stops hiking rates? 

Housing market authorities predict mortgage rates will inch lower in the coming months. Again, even though economic data shows signs of progress, the Fed won’t consider cutting rates until it feels confident that inflation is steady at its target annual rate of 2%.

Whether the first interest rate cut happens at the March, May or June FOMC meeting is to be determined. That means we’re not likely to see average rates drop below 6% for a while. 

“The new normal will be near 6.5% and will bounce around this figure for most of the year,” according to Lawrence Yun, chief economist at the Nation Association of Realtors.

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. 

However, 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 what’s happening with 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 Odeta Kushi, deputy chief economist at First American Financial Corporation. 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.

However, 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 decision to hold rates steady won’t have a dramatic or immediate impact on home loan rates. Instead, mortgage rates will respond to inflation, investor expectations and the broader economic outlook. The general consensus, though, is that mortgage rates will slowly trend down throughout 2024. 

 

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.

Katherine Watt is a CNET Money writer focusing on mortgages, home equity and banking. She previously wrote about personal finance for NextAdvisor. Based in New York, Katherine graduated summa cum laude from Colgate University with a bachelor's degree in English literature.
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