The Federal Reserve has resumed its war on inflation. After raising rates 10 times in 10 meetings in 2022 and 2023, the central bank took a break in June. But at its July 26 meeting, it was back to fighting form: Fed chairman Jerome Powell announced a quarter-point increase in interest rates.
Earlier in the inflationary cycle, the Fed had enacted increases of as much as three-quarters of a point. Now that inflation is down to 3% — close to its official target of 2% — some housing economists think we are near the end of this round of tightening. “We do expect mortgage rates to trend down once the (Federal Open Markets Committee) clearly signals that they have reached the peak for this cycle, as the reduction in uncertainty with respect to the direction of rates should narrow the spread of mortgage rates relative to Treasury benchmarks,” says Mike Fratantoni, chief economist at the Mortgage Bankers Association.
In an effort to rein in inflation, the Fed boosted interest rates by a quarter-point in March 2022, then by a half-point in May 2022. It raised them even more in June 2022, by three-quarters of a percentage point — which was, at the time, the largest Fed rate hike since 1994. The hikes aimed to cool an economy that was on fire after rebounding from the coronavirus recession of 2020. That dramatic recovery has included a red-hot housing market characterized by record-high home prices and microscopic levels of inventory.
However, for months now the housing market has shown signs of cooling. Home sales have dropped sharply, and appreciation slowed nationally, with home prices dropping in many previously overheated markets. Home prices are not driven solely by interest rates, though, but by a complicated mix of factors — so it’s hard to predict exactly how the Fed’s efforts will affect the housing market.
Higher rates are challenging for both homebuyers, who have to cope with steeper monthly payments, and sellers, who experience less demand and/or lower offers for their homes. After topping 7% last fall, mortgage rates dipped back down slightly, with the rate on a 30-year mortgage averaging 6.3% in early February. But that rate is inching back up. It stood at 6.98% as of July 26, according to Bankrate’s national survey of lenders.
How the Fed affects mortgage rates
The Federal Reserve does not set mortgage rates, and the central bank’s decisions don’t move mortgages as directly as they do other products, such as savings accounts and CD rates. Instead, mortgage rates tend to move in lockstep with 10-year Treasury yields.
“Mortgage rates don’t take direct cues from the Fed and will instead respond to the outlook for the economy and inflation,” says McBride. Still, the Fed’s policies set the overall tone for mortgage rates. Mortgage lenders and investors closely watch the central bank, and the mortgage market’s attempts to interpret the Fed’s actions affect how much you pay for your home loan.
The Fed bumped rates seven times in 2022, a year that saw mortgage rates jump from 3.4% in January all the way to 7.12% in October before inching back down again. “Such increases diminish purchase affordability, making it even harder for lower-income and first-time buyers to purchase a home,” says Clare Losey, assistant research economist at the Texas Real Estate Research Center at Texas A&M University.
But home prices seem to be stabilizing. Prices declined for seven straight months through January 2023 but have risen slightly since then, according to the Case-Shiller U.S. National Home Price NSA Index. And the National Association of Realtors said home prices fell in June 2023 compared to June 2022, but not by much — the median price for the month was $410,200, the second-highest monthly reading ever.
How much do mortgage rates affect housing demand?
There’s no doubt that record-low mortgage rates helped fuel the housing boom of 2020 and 2021. Some think it was the single most important factor in pushing the residential real estate market into overdrive.
Then, in late 2022, mortgage rates surged higher than they had been in two decades, and the housing market slowed dramatically. Economists expect price declines this year of anywhere from a few percentage points to more than 20%.
Yet, in the long term, home prices and home sales tend to be resilient to rising mortgage rates, housing economists say. That’s because individual life events that prompt a home purchase — the birth of a child, marriage, a job change — don’t always correspond conveniently with mortgage rate cycles.
History bears this out. In the 1980s, mortgage rates soared as high as 18%, yet Americans still bought homes. In the 1990s, rates of 8% to 9% were common, and Americans continued snapping up homes. During the housing bubble of 2004 to 2007, mortgage rates were higher than they are today — and prices soared.
So the current slowdown may be more of an overheated market’s return to normalcy rather than the signal of an incipient housing crash. “The combination of elevated mortgage rates and steep home-price growth over the past few years has greatly reduced affordability,” Fratantoni says.
But if mortgage rates pull back, affordability will become less of a factor. For instance, borrowing $320,000 at last year’s peak rate of 7.12% translated to a monthly payment of $2,154. Taking a mortgage for the same amount at February’s rate of 6.3% meant a monthly payment of $1,980 — a difference of $174 a month.
Powell: ‘This will take some time to work through’
After Powell’s July announcement, Bankrate’s senior economic analyst, Mark Hamrick, asked the Fed chair about whether the housing market can recalibrate itself while inventory remains so low, and rates remain so high.
“There are many people who have low-rate mortgages, which means that supply of existing homes is really, really tight. Which is keeping prices up,” Powell continued. “I think this will take some time to work though. Hopefully more supply comes online and, you know, we work through it.”
Next steps for borrowers
Here are some pro tips for dealing with elevated mortgage rates:
- Shop around for a mortgage. Savvy shopping can help you find a better-than-average rate. With the refinance boom considerably slowed, lenders are eager for your business. “Conducting an online search can save thousands of dollars by finding lenders offering a lower rate and more competitive fees,” McBride says.
- Be cautious about ARMs. Adjustable-rate mortgages may look tempting, but McBride says borrowers should steer clear. “Don’t fall into the trap of using an adjustable-rate mortgage as a crutch of affordability,” he says. “There is little in the way of up-front savings, an average of just one-half percentage point for the first five years, but the risk of higher rates in future years looms large. New adjustable mortgage products are structured to change every six months rather than every 12 months, which had previously been the norm.”
- Consider a HELOC. While mortgage refinancing is on the wane, many homeowners are turning to home equity lines of credit (HELOCs) to tap into their home equity. The rationale is simple: If you need $50,000 for a kitchen renovation and you have a mortgage for $300,000 at 3%, you probably don’t want to take out a new loan at 6.8%. Better to keep the 3% rate on the mortgage and take a HELOC — even if it costs 8%.