What will mortgage interest rates look like when the Fed cuts rates?
Mortgage interest rates plummeted during the pandemic in 2020 and 2021, with rates on 30-year mortgage terms as low as 2.71%. But as the pandemic waned and inflation surged, the Federal Reserve raised its federal funds rate numerous times. That eventually led to the rate hitting a range between 5.25% and 5.50%, its highest point in 23 years. Mortgage rates rose in tandem, rising to their highest level since 2000 last summer. As the federal funds rate remained frozen for much of the last year, mortgage rates only dropped a marginal amount.
But the rate climate is about to change.
Following a series of encouraging inflation reports (the rate dropped in April, May and June) and major progress toward getting the rate toward a target goal of 2%, cuts to the federal funds rate now appear likely. That seemed to be the message after the Fed kept the rate unchanged at their meeting this week. And the CME FedWatch tool now projects a reduction in the rate to a range between 5.00% and 5.25% at a more than 80% likelihood.
But what does all this mean for homebuyers and what will mortgage interest rates actually look like when the Fed cuts rates? That's what we'll break down below.
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What will mortgage interest rates look like when the Fed cuts rates?
While mortgage interest rates will inevitably fall when the Fed cuts rates, and may even start to decline slightly before that formal action, the initial drop is likely to be minimal and will only result in partial monthly savings for buyers. With the average mortgage rate on a 30-year loan at 6.86% as of August 1, a drop of 25 basis points will result in a new average of 6.61% for borrowers. While that can result in $23,795 saved over the life of the loan (based on the average home cost of $398,000), it'll only save borrowers around $66 a month ($2,610.59 at 6.86% versus $2,544.49 at 6.61%).
However, that doesn't mean that additional savings opportunities aren't possible ahead. If the Fed issues multiple interest rate cuts, mortgage rates will fall numerous times as well. So 6.61% could become 6.36% and 6.11% after that. But it will take months, if not years, for these rate cuts to be issued and reverberate through the mortgage environment. And inflation will need to remain controlled for these cuts to be issued, or they could be halted or even reversed.
Even with that understanding, buyers should know that the chances of mortgage rates hitting the 3% to 4% range that they were in a few years ago is highly unlikely. So it may make sense for some borrowers to act now, particularly if they've already located their dream home.
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Boost your credit score
Ahead of interest rate cuts in September and beyond homebuyers should make select moves now, with boosting their credit score arguably being the most important. Remember that the aforementioned interest rates will be reserved for borrowers with the highest credit scores and cleanest credit histories. If you don't have those, you'll be offered above-average rates on your mortgage loans. So start the work on boosting your credit score today.
This includes paying down debt (or, ideally, paying it off completely). But it extends to paying your current bills on time (or early) and refraining from applying for other credit types which could result in hard inquiries on your credit report and, thus, a decline in your score. You should also take a close look at your credit report for any inaccuracies or issues that would require disputing. It's critical to start this work now, however, as it will take time for your score to rise.
The bottom line
Interest rate cuts on the horizon could dramatically change the homebuying landscape but it'll be slow to start. Rate cuts are only expected to be issued in 25 basis points increments, so major relief is still some time away. But every reduction helps, particularly when added up over the lifespan of the loan. So buyers should start preparing for this opportunity now by boosting their credit score as high as possible so that they're ready to act.
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