When will mortgage interest rates drop? 3 factors influencing rates now

News on the economic front is mixed in recent weeks. While the unemployment rate continues to improve after dropping to 3.6% in June, inflation and interest rates remain elevated. The current economic environment has made it harder for Americans who want to buy a home or refinance their existing mortgages.

A decrease in mortgage rates would be welcome news to anyone looking to buy a home or refinance their mortgage, but when will that be? We asked a few experts about what's influencing rates now and when mortgage interest rates will eventually drop.

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3 factors influencing mortgage rates today

Here's what experts say are influencing today's mortgage rates - and when buyers and owners can expect them to drop again.

1. Inflation

No surprise here. All the experts we spoke with agree that inflation, along with the Federal Reserve's efforts to control it, remains a primary factor contributing to today's higher mortgage rates. According to Freddie Mac, mortgage rates are at their highest level since November 2022. The average mortgage rate on a 30-year fixed-rate mortgage is 6.96% as of mid-July 2023.

Greg Forest, a senior global real estate advisor at Sotheby's International Realty, is among the experts attributing elevated mortgage rates to the Fed's influence. "Inflation and the Federal Reserve's response play a significant role in today's elevated rates," says Forest. "The Federal Reserve has reacted swiftly to inflation concerns by implementing historic rate increases. In my opinion, too swiftly increasing caused a significant increase."

Forest sees rates rising before they drop. "I believe we'll see the pace of inflation will have a heavy weight on rates. I expect mortgage rates to maintain a slight rise until the end of this year [or] beginning of 2024, when I expect them to start to fall."

Aaron VanTrojen, CEO of Geneva Financial, agrees that mortgage rates likely won't drop for some time in part because long-term rates (mortgage rates) tend to follow the short-term rates (Fed Funds rate), which figure to remain higher. "They have been stating this for some time and have been doing just that; intensive interest rate hikes," says VanTrojen. 

"There is no reason today to believe that they are not going to follow through with what they have been repeatedly stating for some time. The Fed did not anticipate monetary easing until well into 2024."

2. Prepayment risk

While Peter Idziak, senior associate at Polunsky Beitel Green, points to inflation as a primary driver of higher mortgage rates, he observes it's not the only factor: "The other major factor driving rates higher is that investors expect rates to decrease over the next few years," says Idziak. "Mortgages they purchase today are likely to be paid off earlier than historical averages. To compensate investors for this prepayment risk, mortgage rates have had to move even higher."

So when will mortgage interest rates drop? "I expect we will see rates start to decrease later in 2023," says Idziak. "The Fed has previously signaled it expects to only raise rates two to three more times, and the June CPI inflation data came in cooler than expected, so we should be close to the end of the Fed's rate-hiking campaign."

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3. Treasury yields

Generally, mortgage rates tend to follow 10-year Treasury rates. The 30-year fixed mortgage rate remains, on average, 1.7 percentage points (equivalent to 170 basis points) higher than the yield on the 10-year Treasury bonds. However, the spread can widen amid economic or geopolitical uncertainty, as it is today.

As Christine Cooper, the chief U.S. economist and managing director at CoStar Group, notes, the spread has widened to over 280 in 2023. As a result, "Mortgage rates are higher than they would be in a calmer economic environment. A combination of factors drives this spread, including lenders' perceptions of repayment risks and demand in the MBS market," states Cooper.

Because the Fed is likely to raise rates at least one more time this year, Cooper expects mortgage rates to remain high in the short term before we see a drop. "As economic growth slows and inflation abates, the 10-year Treasury is likely to move lower, and mortgage rates will follow, with the spread between them narrowing to a more normal range," says Cooper. "Projections suggest the 30-year rate to fall below 6% by the end of 2023 and to be between 5% and 5.5% at the end of 2024."

The bottom line

If you're waiting for mortgage rates to drop before buying or refinancing a home, there are still actions you can take to improve your financial position. For example, making repairs or home improvements may boost your home's value and allow you to fetch a higher price when you do decide to sell. A home equity loan or home equity line of credit can help finance those projects. 

It's also a good idea to take steps to improve your credit before you refinance your home. Having a credit score that falls in the good or excellent credit ranges can improve your odds of loan approval and secure favorable rates.