Why 2% Mortgage Rates Are a Thing of the Past

It's easy to hold up sub-3% mortgage rates as the gold standard. Four years ago, the average rate for a 30-year fixed mortgage was 2.65%. Bargain mortgage rates made it cheaper to purchase a house and refinance a mortgage, and the number of borrowers taking out new home loans reached a more than two-decade high. 

But don't forget. We were also in the middle of a global pandemic and an economic downturn, with widespread unemployment, investment losses and financial instability. 

Mortgage rates typically fall during a recession. Bad news for the economy is often good news for mortgage rates. To repeat that kind of low-rate environment would indicate major problems in the economy, said Alex Thomas, senior research analyst at John Burns Research and Consulting.

A lot has changed since the homebuying boom of 2020-21. Elevated mortgage rates, high inflation, limited housing inventory and rising home prices have frozen the housing market, making it nearly impossible for the majority of Americans to afford a home. 

With inflation having cooled, the Federal Reserve has started cutting interest rates. Mortgage rates could move down toward 6% in early 2025. Later next year, rates in the mid-5% are a possibility. 

Yet forecasts are changing. With the incoming Trump administration, a lot will depend on policy changes and their economic impact. New tax cuts and tariffs could push up inflation and keep interest rates high, preventing mortgage rates from falling.

While prospective homebuyers are waiting for mortgage rates to ease, it's unlikely we'll see record-low mortgage rates anytime soon. Today's higher rates can be a tough pill to swallow, but it's possible to get a better deal on your mortgage (more on that below). 

How did mortgage rates plunge below 3%?

First, to understand how mortgage rates dropped to rock-bottom levels, we can look at the relationship between the economy and the federal funds rate, a short-term interest rate that determines what banks charge each other to borrow money. 

Though the Fed doesn't directly set mortgage rates, when it raises the federal funds rate, banks also raise interest rates on home loans to keep their profit margins intact. This impacts longer-term interest rates like 30-year fixed mortgage rates.

In a recession, however, the Fed tries to spur economic growth through quantitative easing, i.e., cutting the federal funds rate to encourage consumer spending and borrowing, and increasing its purchase of government-backed bonds and mortgage-backed securities.

To put it simply, the Fed keeps that benchmark rate low when it needs to stimulate economic growth. Let's go back to the 2008 financial crisis, for example, when the Fed slashed interest rates to zero to bolster the economy. When there were signs of recovery in 2015, the central bank started raising interest rates again, sending mortgage rates into the 4% to 5% range until 2020. 

The COVID-19 pandemic then sparked another economic crisis. To incentivize people to borrow money and to avoid a prolonged recession, the Fed once again cut the federal funds rate to near zero and pumped money into the economy. Mortgage interest rates fell quickly, bottoming out in the mid-2% range in 2021. 

Then, a combination of supply shocks, record-low rates and an extreme increase in money supply from government stimulus helped to send prices way up, said Erin Sykes, founder of real estate company Sykes Properties. 

By early 2022, the Fed had a new problem on its hands: inflation.

How did mortgage rates then surge past 8%? 

To understand how mortgage rates more than doubled over the last couple of years, let's look again at the relationship between the economy and the federal funds rate. With consumer price growth surging in 2022, the Fed's main tool was to adjust interest rates higher, making credit more expensive and disincentivizing borrowing. This kind of quantitative tightening slows the economy and reduces the money supply in financial markets, putting upward pressure on longer-term interest rates, like 30-year fixed mortgage rates.

After a string of aggressive rate hikes, the federal funds rate went from near zero to a range of 5.25% to 5.5%. Average mortgage rates skyrocketed, peaking past 8% in late 2023. 

Once inflation showed consistent signs of cooling in 2024, the Fed began cutting interest rates. Following its first cut in September and a second cut in November, it's expected to carry out a series of interest rate reductions throughout 2025. 

Mortgage rates, while still elevated, have fallen into the 6% to 7% range and should continue easing at a slow pace. But the road there could be long and bumpy. It's unlikely we'll see the average rate on a 30-year fixed mortgage drop below 6% in the next several months. 

Why won't mortgage rates drop to 2% again?

Again, when mortgage rates hit record lows early in the pandemic, the federal funds rate was near zero. Barring another major economic shock, the Fed projects that the federal funds rate will only take modest adjustments downward over the next several years. 

In fact, in March, Fed Chair Jerome Powell remarked that interest rates "will not go back down to the very low levels that we saw" during the financial crisis, suggesting that the economy can adapt to a more "neutral" benchmark rate range of between 2.4% to 3.8% in the long run, i.e., less tightening, but not too much easing from the current range of 4.5% to 4.75%.

Only a dramatic economic shock, such as a pandemic or recession, would force the Fed to lower rates close to zero, said Selma Hepp, chief economist at CoreLogic. In that scenario, and if the central bank started purchasing government bonds and mortgage-backed securities again, there's a possibility mortgage rates could return to record lows. 

However, without a major downturn or global catastrophe, it's highly unlikely that mortgage rates will drop to their 2020-21 levels. In fact, many economists and housing market experts hope they don't. 

In the long term, mortgage rates may stabilize between 5.5% and 6%, which is a historically normal range.

How to cope in an era of higher mortgage rates 

When you monitor mortgage rate movement, you're usually looking at national averages determined by weekly rate information provided by lenders. While those rates give a picture of the "typical" mortgage rate, that's not necessarily the number you'll get when applying for a mortgage. You can actually score a lower rate. 

For example, though most lenders require a minimum credit score of 620 to qualify for a mortgage, lenders offer the lowest mortgage rates to consumers with excellent credit scores, around 740 and above.

Another option is to purchase mortgage points, also known as discount points, to get a lower interest rate. As an extra fee you pay upfront, each mortgage point typically costs 1% of the purchase price of a home and will lower your mortgage rate by 0.25%.

Changing your loan term can also help lower your rate: A shorter-term loan like a 15-year or 10-year mortgage will have a lower interest rate than a 30-year fixed mortgage. Your monthly payments will be higher with a shorter-term loan because you're paying the loan off in less time, but you'll save big on interest. 

Buying a home is likely the biggest transaction you'll make in your lifetime. Though many homebuyers have been patiently hoping mortgage rates will drop before entering the housing market, waiting for a return of ultralow mortgage rates is a losing game.

Regardless of the market, carefully assess your needs and what you can afford. 

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