Are you still on the hunt for a 2% mortgage rate? This is why it’s time to let them go
As much as we’d like to think that mortgage rates will drop back below 3%, potential homebuyers shouldn’t hold their breath.
Four years ago, when the average interest rate for a 30-year mortgage fell to 2.65%it was much cheaper to buy a house and refinance a mortgage. The number of borrowers who took out a new home loan reached a level more than twenty years high.
But that favorable mortgage interest also came with costs. The global pandemic caused a severe economic downturn, with widespread unemployment, investment losses and financial instability.
Bad news for the economy is often good news for the mortgage market. Normally, mortgage rates would only reach this level during a recession. A repeat of these types of low interest rates would indicate major problems in the economy, he said Alex Thomassenior research analyst at John Burns Research and Consulting.
The housing market has changed a lot since the homebuying boom of 2020-2021. Higher mortgage rates, high inflation, limited housing inventory and rising home prices have made it virtually impossible for the majority of Americans to afford a home.
Now that inflation has cooled, the Federal Reserve has started cutting interest rates. Mortgage interest rates could fall towards 6% in early 2025. Interest rates around 5% are possible later next year.
However, the predictions are constantly changing. With the incoming Trump administration, much will depend on policy changes and their economic impact. New tax cuts and rates could push up inflation and keep interest rates high, preventing an easing of mortgage rates.
Today’s higher interest rates can be a tough pill to swallow, but keep in mind that 7% has been the average rate for a 30-year fixed mortgage since the 1970s. Plus, it’s possible to get a better deal on your mortgage (more on that below).
Read more: Current mortgage rates are not the highest we have ever seen
How mortgage rates fell below 3%
To understand how mortgage rates fell to record lows, let’s first look at the relationship between the economy and the federal funds rate, a short-term interest rate that determines what banks charge each other to lend money.
Although the Fed does not directly set mortgage rates, when it raises the federal funds rate, banks also raise home loan rates to keep their profit margins intact. This has consequences for longer interest rates, such as the mortgage interest rate with a fixed term of 30 years.
However, in a recession, the Fed tries to stimulate economic growth quantitative easingi.e., lowering the federal funds rate to encourage consumer spending and borrowing, and increasing the purchase of government-backed bonds and mortgage-backed securities.
Simply put, the Fed keeps interest rates low when it needs to stimulate economic growth. For example, let’s go back to the 2008 financial crisis, when the Fed cut interest rates to zero to stimulate the economy. When there were signs of recovery in 2015, the central bank started raising interest rates again, causing mortgage rates to fluctuate between 4% and 5% until 2020.
The COVID-19 pandemic then led to a new economic crisis. To encourage people to borrow money and avoid a prolonged recession, the Fed cut the federal funds rate again to near zero and pumped money into the economy. Mortgage rates fell rapidly, reaching a low of mid 2% in 2021.
Then a combination of supply shocks, record-low interest rates and an extreme increase in the money supply due to government stimulus helped push prices higher, according to Erin Sykesfounder of real estate company Sykes Properties.
At the beginning of 2022, the Fed had a new problem: inflation.
Read more: Weekly mortgage forecasts
How mortgage rates then rose past 8%
To understand how mortgage rates have more than doubled in recent years, let’s take another look at the relationship between the economy and the federal funds rate. With consumer price growth surging in 2022, the Fed’s main tool has been to raise interest rates, making credit more expensive and discouraging borrowing. This kind quantitative sharpening slows the economy and reduces the money supply in the financial markets, putting upward pressure on longer-term interest rates, such as the 30-year fixed mortgage rate.
After a series of aggressive rate hikes, the federal funds rate went from near zero to a range of 5.25% to 5.5%. The average mortgage interest rate skyrocketed and peaked above 8% at the end of 2023.
When inflation showed consistent signs of cooling in 2024, the Fed began cutting rates. After the first cut in September and a second cut in November, the country is expected to implement a series of interest rate cuts over the course of 2025.
While mortgage rates are still high, they have fallen to the 6% to 7% range and should continue to ease at a slow pace. But the road to get there can be long and bumpy. It’s unlikely we’ll see the average 30-year mortgage rate fall below 6% in the coming months.
Why mortgage interest rates will not return to 2%
When mortgage rates hit record lows early in the pandemic, the federal funds rate was again near zero. Barring another major economic shock, the Fed expects the federal funds rate to do just that make only modest downward adjustments in the coming years.
In fact: in March Fed Chairman Jerome Powell noted that interest rates “will not return to the very low levels we saw during the financial crisis,” suggesting that the economy can adjust to a more “neutral” range of between 2.4% to 3.8% in the long term: less tightening, but not too much easing of the current range from 4.5% to 4.75%.
Only a dramatic economic shock, such as a pandemic or recession, would force the Fed to cut interest rates to near zero, the US central bank said Selma Heppchief economist at CoreLogic. In that scenario, and if the central bank were to resume purchasing government bonds and mortgage-backed securities, there is a possibility that mortgage rates could return to record lows.
However, without a major downturn or global catastrophe, it is highly unlikely that mortgage rates will fall to 2020-2021 levels. Many economists and housing market experts even hope that this is not the case.
In the long term, mortgage rates may stabilize between 5.5% and 6%, which is historically a normal range.
How to Adjust to Higher Mortgage Rates
When you monitor mortgage interest rates, you usually look at national averages that are determined based on weekly interest rate data from lenders. Although these rates give an idea of the ‘typical’ mortgage rate, that is not necessarily the figure you will receive when you apply for a mortgage. You can even score a lower rate.
For example, while most lenders require a minimum credit score of 620 to qualify for a mortgage, lenders offer the lowest mortgage rates to consumers with excellent credit scores, around 740 and above.
Another option is to purchase mortgage points, also called discount points, to get a lower interest rate. As an additional fee you pay upfront, each mortgage point typically costs 1% of the purchase price of a home and reduces your mortgage interest rate by 0.25%.
Changing the term of your loan can also lower your interest rate: a loan with a shorter term, such as a 15 or 10-year mortgage, has a lower interest rate than a 30-year fixed mortgage. Your monthly payments will be higher with a shorter term loan because you pay off the loan in less time, but you will save a lot on interest.
Buying a house is probably the largest transaction you will make in your life. While many homebuyers have patiently hoped that mortgage rates will drop before entering the housing market, waiting for a return to ultra-low mortgage rates is a losing proposition.
Regardless of the market, carefully assess your needs and what you can afford.
