Fed Rate Cut and Impact on Mortgage Rates

It happened!

Today, the Federal Reserve cut its benchmark interest rate by 25 basis points. Officials also signaled the possibility of two more rate cuts this year.

Now that it's official, how will the Fed's cut impact mortgage rates? It's a question we get all the time.

The rate cut – the Fed’s first since late 2024 – lowers the Fed’s benchmark interest rate to a range of 4% to 4.25%. In fact, mortgage rates had already been falling, anticipating the Fed's widely expected move. Last week, for example, the average interest rate on a 30-year fixed mortgage stood at 6.35%, the lowest in nearly a year. 

A quarter-point reduction in the Federal Reserve's interest rate, while seemingly small, can have a noticeable impact on U.S. mortgage rates, particularly for potential home buyers. It's important to understand that the Federal Funds Rate, which the Fed directly controls, isn't the same as mortgage rates. However, they are intrinsically linked.

The Fed's Role and Its Indirect Influence

The Federal Reserve primarily influences short-term interest rates through the Federal Funds Rate, which is the target rate for overnight lending between banks. When the Fed reduces this rate, it signals an easing of monetary policy, typically done to stimulate economic growth. This reduction makes it cheaper for banks to borrow from each other, and this lower cost of funds can trickle down to consumers.

Mortgage rates, particularly for fixed-rate mortgages, are more closely tied to the yield on U.S. Treasury bonds, especially the 10-year Treasury note. Treasury yields are influenced by various factors, including inflation expectations, economic growth forecasts, and, crucially, the Federal Reserve's monetary policy.

How a .25 Basis Point Cut Plays Out

When the Fed cuts rates by 0.25 basis points (which is 0.25%), it generally leads to a decrease in the yield on Treasury bonds. This is because investors anticipate lower inflation and slower economic growth, making the fixed income of Treasuries relatively more attractive. As Treasury yields fall, so too do mortgage rates. However, the impact isn't always a direct 1:1 correlation.

Several factors can moderate or amplify the effect:

• Market Expectations: Financial markets often "price in" anticipated Fed actions. If a 0.25% cut is widely expected, mortgage rates may have already adjusted beforehand, leading to a less dramatic movement on the day of the announcement. Indeed, mortgage rates had already been falling, anticipating the Fed's widely expected move. Last week, for example, the average interest rate on a 30-year fixed mortgage stood at 6.35%, the lowest in nearly a year. 
• Economic Data: Ongoing economic data, such as inflation reports, employment figures, and GDP growth, can also influence Treasury yields and, by extension, mortgage rates. Strong economic data might temper the downward pressure on rates from a Fed cut, while weak data could amplify it.
• Global Events: Geopolitical events or global economic trends can also play a role, sometimes overshadowing domestic interest rate changes.
• Lender Behavior: While lenders generally follow market trends, their individual pricing strategies can also vary, leading to slight differences in the rates offered.

Moreover, consider this:

• Home prices are still at record highs in many U.S. cities. (This is particularly true in desirable areas where demand continues to outpace supply. For example, cities like Milwaukee, Chicago, and Detroit have seen significant price increases, reaching or approaching new highs.)
• Inventory is low; even as listings have been increasing annually, they still lag significantly behind pre-pandemic levels.
• The impact of tariffs on the cost of building materials like Canadian wood will have an impact on home building, and therefore home inventory. Higher material costs will also impact buyers who plan to buy a distressed property and rehab it. Mortgage rates could even rise if tariffs end up pushing up inflation.

What Does This Mean for Home Buyers?

For potential home buyers, a 0.25 basis point reduction in the Fed rate generally translates to slightly lower mortgage rates. While it might not seem like a huge drop on a percentage basis, even a small reduction can result in significant savings over the life of a 15-year or 30-year mortgage.

For example, a quarter-point reduction on a $300,000 mortgage could save a buyer hundreds to thousands of dollars in interest over the loan term, and also reduce their monthly payment. This can improve affordability, potentially allowing more buyers to enter the market or qualify for a larger loan.