For Home Buyers, Fed’s Big Cut Is Likely Just a Small Step Toward Buying a Home

The Federal Reserve gave home buyers what they were hoping for this week: a sharp rate cut and a signal of more cuts to come.

Still, prospective homebuyers and homeowners looking to refinance should temper their expectations for a sharp drop in mortgage rates from now on.

Even though the Fed doesn’t set mortgage rates, its policy change sets the stage for lower mortgage rates. But in this case, the Fed’s action was widely anticipated, so rates fell well before the cut was even announced.

“We’ve already seen most of the easing that we’re going to see this year,” said Danielle Hale, chief economist at Realtor.com. “I wouldn’t be really surprised if mortgage rates go up a little bit and then come down again.”

When mortgage rates rise, they can add hundreds of dollars a month to borrowers’ costs. The average rate on a 30-year mortgage rose from less than 3% in September 2021 to 7.8% last October, its highest level in 23 years. The increase coincided with the Fed raising its benchmark interest rate to combat inflation.

Rates have mostly fallen since July in anticipation of a Fed rate cut. The average rate on a 30-year mortgage is now 6.09%according to mortgage buyer Freddie Mac. That’s down from 7.22% in May, its peak so far this year.

Even modest mortgage rate cuts can add up to significant savings over the long term. For a home that sold for the median price of $416,700 in the U.S. last month, a Los Angeles buyer who puts down 20% at today’s average mortgage rate would save about $312 per month compared to what it would have cost to buy the same home in May.

While lower interest rates give home buyers more purchasing power, a mortgage of about 6% is still not low enough for many Americans struggling to afford a home. That’s largely because home prices have climbed 49% over the past five years, about double the rate of wage growth. They remain near their all-time highs, supported by a housing shortage in many markets.

Mortgage rates would have to return to levels close to their lows of three years ago, or housing prices would have to fall dramatically for many buyers to be able to afford a home. Neither scenario is likely to happen in the near future.

Economists and mortgage industry executives expect mortgage rates to remain near current levels, at least this year. Fannie Mae forecast this week that the rate on a 30-year mortgage will average 6.2% in the October-December quarter and fall to an average of 5.7% in the same quarter next year. It averaged 7.3% in the same period in 2023.

Mortgage rates are influenced by several factors, including how the bond market reacts to the Fed’s interest rate decisions. That can change the trajectory of the 10-year Treasury yield, which lenders use as a guide to price home loans.

“Ultimately, the pace of mortgage rate cuts and the Fed’s pace will be driven by economic data,” said Rob Cook, vice president of Discover Home Loans. “If future data shows the economy slowing more than expected, that would increase pressure on the Fed to take more aggressive action in cutting rates, which would likely translate into lower mortgage rates offered to consumers.”

Sales of previously occupied U.S. homes have been declining sharply since 2022, and fell 2.5% last monthSo far, the decline in mortgage rates has not yet triggered a significant rebound, although sales increased slightly in July.

The mixed outlook for mortgage rates leaves potential buyers and sellers facing a familiar dilemma: test the housing market now or wait for potentially lower rates.

Nick Young, a lawyer who moved his family this year from Phoenix to Evergreen, Colo., chose to rent after seeing how competitive the home-buying market was last spring.

With a home buying budget of between $1 million and $1.5 million, he and his wife are still searching for the perfect gem: a five-bedroom home in which to grow up with their three children.

They watch mortgage rates, but also other variables, including inflation, the health of the overall economy and the presidential election.

“There’s not a lot of incentive to buy right now,” Young said before the Fed announcement. “But timing the market is a thankless task.”

Real estate agents from Phoenix to Tampa, Florida, say many home buyers are waiting for mortgage rates to drop below 6%. Some are hoping rates will return to the lows of three years ago.

“I try to bring them back to reality,” says Mike Opyd, a broker with Re/Max Premier in Chicago. “I tell them, ‘If you really want to buy, do it now.'”

Opyd said falling mortgage rates and a rebound in housing supply are providing a favorable backdrop for homebuyers this fall, a typically quieter time of year for home sales.

Until rates drop further next year, buyers could face increased competition to get the homes they want. In the meantime, potential sellers could stay put.

“Keep in mind that 76% of people with a mortgage have a rate below 5%,” said Leo Pareja, CEO of eXp Realty. “So we could see the supply-demand imbalance get a little bit worse in the short term.”

New home buyers Drew Yae and his wife purchased a two-bedroom, one-and-a-half-bathroom townhouse in Bellingham, Washington, last month.

In February, Yae, a compensation analyst, was offered a mortgage rate of 7%. When the deal closed, his rate was only about 6.63%.

“I would like to refinance at 5% or 5.25%, but I don’t know if that’s realistic and if it’s going to take more than two years to get there,” he said.

Yae could reduce his monthly payment by about $300 per month if he refinances his $407,000 home loan to 5.5%.

A rule of thumb to consider when refinancing is whether you can reduce your current rate by half to three-quarters of a percentage point.

Demand for home loan refinancing is on the rise. Last week, refinancing applications jumped 24%, according to the Mortgage Bankers Association.

Lenders are increasingly turning to the old “date the rate” adage by tying initial loans to refinance incentives right from the start. After buyers saw record low interest rates that peaked about a year ago at around 8%, many are offering deals that essentially give buyers a way out of their current rate once it drops in order to ease buyer hesitation.

“There’s a growing focus on this,” said Mike Fratantoni, the MBA’s chief economist. “Being locked into a 7% rate for life is terrifying for a first-time buyer.”

Navy Federal Credit Union said it began offering its popular “no-refinance rate drop” in 2023, which allows buyers to lower their rate for a $250 fee while retaining the rest of the original loan terms.

Many homebuyers are opting for both the temporary rate cuts and the no-cost refinancing, said Darik Tolnay, branch manager of CrossCounty Mortgage in Lakewood, Colorado.

“They all want housing, so if someone comes up with an idea to make it more affordable, given the general sentiment, people are desperate to have options,” Tolnay said.