It’s finally happened. After months of speculation, the Federal Reserve has started cutting away at the federal funds rate. Markets have already reacted with a bit of excitement, and we’ve been warned to expect more cuts before the year is out.
But as borrowing gets cheaper, a lot of Americans are going to be left wondering: What does all of this mean for my mortgage payments?
Mortgage rates have been slowly rising for the last 20 years. The average 30-year rate is currently sitting at 6.26%, and that’s been enough to keep a lot of aspiring homeowners and would-be investors from taking the plunge.
If this sounds familiar, you might want to start getting organized so you’re ready to dive in. The good news is that rate cuts are going to mean lower mortgage rates. But it’s important to know that mortgage rates and the federal funds rate don’t move in lockstep — and lower borrowing rates also tend to drive up prices.
So, you’re kind of looking at a double-edged sword here.
This is what you need to know:
How Does a Fed Rate Cut Impact Homebuyers?
First thing’s first: You need to understand that the Fed doesn’t set mortgage rates (at least not directly). One of the Fed’s primary tools to control the speed of our economy is the federal funds rate.
This is the overnight rate that banks charge each other for short-term lending. And because mortgages are long-term loans that stretch decades, the interest rates you get on a mortgage are actually tied closer to Treasury yields and the bond market than they are to the federal funds rate.
That being said, the Fed’s new borrowing rate does have an indirect impact on homebuyers in terms of what lenders can afford to offer and demand for housing stock.
Borrowing Will Get Cheaper Over Time
Whenever the Fed cuts rates, Treasury bonds tend to go down, too. That makes sense, because yields decrease when it’s cheaper to borrow money. But this decrease isn’t immediate, and so it might take weeks (or even months) before bond markets really come down. And with two additional rate cuts expected in 2025, we probably won’t see the full impact of all this until early 2026.
The reason it’s important to homebuyers is that most mortgage lenders price new products based on bond yields like the 10-Year Treasury Note ($TNX). As a result, you can expect mortgage rates to drift lower alongside expectations of new cuts in the federal funds rate.
If you’re trying to get your foot on the housing ladder for the first time, even the smallest decline in mortgage rates can have a huge effect on your monthly payments.
For example, let’s say the bank you’re getting a mortgage from drops its 30-year rate from 7% to 6.5%. If you’re trying to take out a $400,000 loan, that rate reduction saves you around $130 per month.
This isn’t a huge amount of money, but it’s enough to ease the pressure on your wallet. It’s also likely enough to push a lot of families off the fence and convince them now is the right time to buy. This should push up demand for housing stock dramatically.
As Borrowing Gets Cheaper, Prices May Climb
The U.S. housing market has been topsy-turvy for a while now.
Because mortgage rates have remained high, pent-up demand has been building over the last two years. Renters have been waiting on the sidelines for the perfect time to pounce, and a sustained period of rate cuts will make taking on a mortgage a lot more attractive.
The issue is that housing supply is still tight in a lot of key regional markets. Right now, the median sale price for a home is sitting at $410,800. While this isn’t quite the all-time high we were looking at in 2022, it’s not far off.
If (or when) mortgage rates really start to drop, competition will heat up and there are going to be way more buyers making stupidly large offers. This creates a sellers’ market and drives up prices significantly.
Translation: The benefits of lower rates are probably going to be slightly offset by bigger price tags.
The Bottom Line
If you’re an existing homeowner with 20 years left on your mortgage loan, a lower Fed rate may not have an immediate impact on your monthly payments.
But it’s still good news and can save you money. The only caveat is that the timing and scale of what you stand to gain is a little less predictable.
A lot of homeowners will be on a fixed-rate mortgage. If this is you, that means you’re locked in at a certain interest rate and even a huge swing in the bond market won’t put a dent in your monthly repayments.
For those sitting on an adjusted-rate mortgage (ARM), Fed rate cuts are a little bit more exciting.
ARM rates are variable and normally tied to short-term benchmarks like the prime rate or Secured Overnight Financing Rate (SOFR). These numbers tend to drop a lot faster and more noticeably when the federal funds rate eases. As a result, variable rate borrowers could see their monthly payments start to fall almost immediately.
But even if you’re locked in to a fixed-rate mortgage, it’s possible to capitalize on these decreasing borrowing rates. The door is always open for homeowners to refinance — and if we see mortgages fall substantially below the 6% mark in the coming months, you can expect a rapid rush to refinance.
It’s important to remember refinancing mid-term will normally include a significant fee. But if you’re looking at a big interest decrease, that short-term pain will still amount to long-term savings. A refinancing wave will also free up household cash flow, which will boost consumer spending more widely.
At the end of the day, bringing down the federal funds rate by 25 basis points isn’t going to send mortgage rates crashing down overnight. It won’t even bring them down much over the next few weeks. But the Fed has signaled there are likely more rate decreases on the horizon, and these sustained cuts will gradually ease borrowing costs.
Just don’t expect a dramatic plunge in your monthly payments, and remember to really shop around before you commit to a new deal or a refinancing offer. There’s going to be a lot of price movement over the coming months, and things are definitely going to get more active as we move into the next buying season.
Watch this space.
