How Will the Federal Reserve's Decisions Impact Mortgage Rates?

The Federal Reserve is set to announce its second interest rate cut at this week's policy meeting on Nov. 7. The country's central bank previously cut its benchmark rate by 0.5% on Sept. 18, its first reduction in more than four years. 

Over the past two and a half years, the Fed's interest rate hikes had an adverse effect on the housing market, helping to drive mortgage rates into unaffordable territory.

Reducing interest rates is preferable to hiking them, but prospective homebuyers shouldn't expect mortgage rates to fall immediately. The Fed doesn't directly set the rates on home loans: Its decisions on monetary policy act as more of a guiding hand for banks and lenders across the country.

Since investor expectations are a key driver of mortgage rate movement, rates tend to move ahead of, not behind, the Fed. 

"The market currently has an assumption about how many cuts there will ultimately be. That assumption is what's priced into today's longer-term rates," said Matt Graham of Mortgage News Daily.

Mortgage rates should ease over the coming 18 months, but they tend to be volatile and can experience daily ups and downs regardless of what the Fed does. The overall state of the economy will play a major role in determining when and by how much borrowing rates are cut.

"The outlook for mortgage rates will depend on incoming labor market and inflation data, along with any signals from the Fed about future rate cuts," said Odeta Kushi, deputy chief economist at First American Financial Corporation.

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. It consists of 12 regional banks and 24 branches, and 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, 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. When the economy is in a slump or downturn, the Fed reduces interest rates to stimulate consumer spending and propel growth.

Read more: How Jobs Data Could Affect Mortgage Rates in 2024

How does the Fed impact mortgage interest rates? 

The Federal Reserve doesn't directly set mortgage rates, but 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 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.

Read more: What Inflation Data Means for Mortgage Rates

How many times will the Fed cut rates in 2024? 

So far, the Fed has made one interest rate reduction in 2024. Its next two policy decisions this year will take place on Nov. 7 and Dec.18. According to its Summary of Economic Projections, the Fed plans to make a 0.25% interest rate reduction at each meeting, but that could always change. 

If we get a slew of strong economic data between now and then, the Fed could shift its plan for rate cuts.

Although mortgage rates are expected to come down in 2025, it will be a slow process. We're not likely to see 30-year fixed mortgage rates drop below 6% for a while. 

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:

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 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.

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.

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