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If you’ve been waiting for the Federal Reserve to lower rates before buying a home, there’s something important to understand:
The Fed doesn’t directly set mortgage rates.
Mortgage rates are heavily influenced by what happens in the bond market, and right now, that market is sending some complicated signals.
Long term Treasury yields remain elevated as investors weigh inflation, government borrowing, economic growth and Federal Reserve policy. For homebuyers, the takeaway is simple: mortgage rates could improve, but a Fed rate cut alone does not guarantee it.
Highlights
- The Fed does not directly control mortgage rates. Mortgage pricing is much more closely connected to the bond market, particularly mortgage backed securities and longer term Treasury yields.
- Government borrowing matters. Large federal deficits require substantial Treasury issuance, increasing the supply of bonds investors must absorb and potentially putting upward pressure on yields.
- Inflation remains critical. If investors believe inflation will remain elevated, they generally demand higher yields to hold long term bonds. That can translate into higher mortgage rates.
- Mortgage rates can fall without a dramatic move from the Fed. Falling Treasury yields, improving mortgage backed securities pricing or tighter mortgage spreads could all help.
- Trying to perfectly time mortgage rates is difficult. Buyers should focus first on whether the home and payment work today, while maintaining the ability to refinance if rates improve.
- Shopping lenders becomes even more important in a volatile market. Small differences in mortgage pricing can translate into meaningful monthly and lifetime savings.
Why Mortgage Rates Aren’t the Same as the Fed Rate
One of the most common misconceptions in mortgage lending is that the Federal Reserve sets mortgage rates.
It doesn’t.
When the Fed raises or lowers its benchmark rate, it has a significant impact on short term borrowing costs. Mortgage rates, however, are long term rates.
Thirty year mortgage pricing is much more closely tied to the market for mortgage backed securities, or MBS. Those securities compete for investor dollars with U.S. Treasury bonds and other long term investments.
That means mortgage rates are influenced by a much broader set of factors, including inflation expectations, Treasury yields, economic growth, federal borrowing, investor demand for bonds, expectations about future Fed policy, and supply and demand within the mortgage backed securities market.
The Fed matters. It just isn’t the whole story.
Why the Bond Market Matters Right Now
The U.S. government has substantial borrowing needs.
Financing large federal deficits requires the Treasury to issue enormous amounts of debt. Investors ultimately have to buy those bonds.
When the supply of bonds grows faster than investor demand, yields may need to rise to attract buyers.
That matters to homeowners because Treasury securities and mortgage backed securities compete for many of the same investors.
If investors can earn an attractive return by owning a virtually risk free Treasury security, they generally require additional yield to purchase mortgage backed securities.
That ultimately affects the mortgage rates offered to consumers.
Inflation Is Still the Wild Card
Inflation is particularly important for long term bonds.
Imagine lending someone money for 10 or 30 years at a fixed interest rate. If you believe inflation will remain elevated during that period, you are going to demand a higher return.
Bond investors think the same way.
When inflation expectations increase, Treasury yields can rise. Mortgage backed securities can follow, pushing mortgage rates higher.
When inflation expectations fall, the opposite can happen.
This is why inflation reports can sometimes move mortgage rates more dramatically than an actual Fed announcement.
Why a Fed Rate Cut Doesn’t Guarantee Lower Mortgage Rates
Suppose the Fed begins lowering short term interest rates.
At first glance, that sounds like great news for mortgages.
But imagine that, at the same time, federal borrowing remains extremely high, investors remain concerned about inflation, Treasury issuance continues increasing, and demand for long term bonds weakens.
Under that scenario, the Fed could lower its benchmark rate while longer term Treasury yields remain elevated.
Mortgage rates could remain stubbornly high as a result.
The reverse can also happen. Mortgage rates can begin falling before the Fed cuts rates if investors become convinced that inflation is declining or economic growth is slowing.
Financial markets price expectations about the future, not just what happened at the latest Fed meeting.
There Is Another Potential Source of Lower Mortgage Rates
Treasury yields are only part of mortgage pricing.
The difference between mortgage rates and comparable Treasury yields is commonly referred to as the mortgage spread.
That spread changes over time.
If investors become more comfortable owning mortgage backed securities, spreads can tighten. That means mortgage rates could improve even without a dramatic decline in Treasury yields.
Conversely, spreads can widen during periods of uncertainty and make mortgage rates worse even when Treasury yields haven’t moved very much.
For borrowers, the important point is that there are multiple paths to lower mortgage rates.
Should You Wait for Lower Rates Before Buying?
Nobody knows exactly where mortgage rates will be six months from now.
That makes trying to perfectly time the mortgage market extremely difficult.
Instead, we believe homebuyers should start with a different question:
Does this home and its payment make sense for me at today’s rate?
If the answer is yes, future rate improvements can become an opportunity rather than a prerequisite.
If rates decline meaningfully, refinancing may allow you to reduce your payment later.
If rates don’t decline, you bought a home you could already afford without depending on a prediction about interest rates.
That is generally a much healthier way to approach the decision.
