🏠 Why rate cuts won’t fix your mortgage

Hey hey, happy Monday! 

Our favorite interest-rate superheroes (the Federal Reserve) cut interest rates last week. The decrease was teeny tiny (25 basis points – or 1/18 of the hikes since 2022), yet Americans have gone mad over the prospects of cheap mortgages.

Today, a 5-minute read on how Fed rate decisions work in the context of mortgage rates, and why this week’s cut (and the ones possibly coming soon) may not be the magic path to affordability some think it is.

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We’re three years into an era of enticing savings rates and uncomfortably high mortgage rates.

A time when you congratulate your friend on snatching a 5% APR savings account. Then, in the next breath, tell him how rough his house payment is.

And let’s be honest – we’re all more than sick of it. Rates are seemingly making the world more expensive, even if banks are throwing a few more pennies at us for cash we’re effectively loaning them. 

I mean, look at this chart on the average 30-year mortgage payment over time, which has nearly doubled since 2019. You’re not the crazy one.

Of course, I now can’t stop hearing about how Federal Reserve cuts will usher us out of this long national nightmare. Just a few of Jay Powell’s wrist flicks and magically rates will be lower, right?

Not so fast, friend.

I’ve had a lot of conversations recently about how rates – primarily, mortgage rates – work.

While changes in interest rates affect nearly every aspect of our financial lives, the idea of rate cuts leading to universally lower rates everywhere is a fallacy.

And I brought the data to prove it.

There’s been a lot of hype around rate cuts lately and what they could mean for a dormant housing market.

After all, mortgage rates are the poster child for how ridiculously expensive housing has become. We all seem to know what a good 30-year fixed rate is at all times, and we salivate over the olden days of 2-3% mortgages that seem to be no more than a faint memory.

For what it’s worth, mortgage rates have moved lower – even if they’re still scorchingly high. The average 30-year fixed rate has dropped to 6.4% from 7% in four months, according to Bankrate. This past week, the Federal Reserve lowered its policy rate by 25 basis points (0.25%).

Low-rate hopefuls have the momentum, but the rate cut may have (ironically) ruined it.

To understand why, you need to know how rate cuts actually work.

If you read any line of this piece, make it this one: the Fed does not directly control mortgage rates.

Instead, the Fed directly controls the rate banks pay to borrow money overnight, and this base rate sets expectations for all other types of interest rates.

Ultimately, you can call mortgage rates a mixture of market rates – or specifically the 10-year Treasury yield – plus some extra percentage points added on for time, default, uncertainty and straight profit (because banks love making money). Wall Street calls this the “mortgage spread”, and the Fed Bank of Richmond wrote an explainer on the spread two years ago.

To know where mortgage rates are going, you need to know where the 10-year yield and the mortgage spread are heading.

Let’s start with the 10-year yield. I’ve written a lot about bond market weirdness this year, and how the 10-year yield is more a reflection of debt concerns and political instability.

Still true! The 10-year yield has dropped recently because jobs data has looked particularly rough. But on balance, it’s still very high, even though other shorter Treasury yields have reacted more to a weaker economy. BTW – when the economy is shaky, you can expect yields to fall as people pile into fixed income for safety.

Today, the job market is suffering, yet other parts of the economy look OK. Inflation has become a problem child again, with year-over-year price growth accelerating for four months straight in Consumer Price Index data.

When inflation and growth are both depressed, a Fed rate cut can lead to lower long-term yields (and mortgage rates). That’s not the case right now. And over history, it’s actually been more common to see higher long-term rates after a rate cut. Since 1970, the 10-year yield has increased in the month after a rate cut 51% of the time.

Luckily, the mortgage spread has gradually come down, too. But if you’re looking for that magic 5.5% mortgage rate (which John Burns Research and Consulting points out as the rate that could entice more Americans to buy and refinance), then you need more than this.

Think about it this way. If you assume a mortgage spread of 2.2% (the average spread over the past 10 years), then you need a 10-year yield at 3.3%. We haven’t seen a 10-year yield at or under 3.3% in three years.

Around this time last year, I wrote a post called “Your dream house or your job?”.

I argued the most viable path to lower mortgage rates – and potentially more affordable houses – may be to make a deal with the devil.

An affordable mortgage, or your job. Choose wisely, because you can only pick one.

Unfortunately, I still think we’re stuck in this impossible dilemma.

For a cheaper housing payment, we’d need one of either mortgage rates or housing prices to fall. We just talked about the predicament with rates. Housing prices are technically decreasing, but with some job market pain attached. If unemployment is rising and Americans are worried about the future, they’re less likely (and able) to go out and make big purchases.

Yes, housing prices can come down with higher supply. But that hasn’t happened yet, and given the divisiveness in DC, I wouldn’t count on new policy stimulating more house-building. Housing supply is rising if you look at active listings, yet building permits have dropped for five straight months (the longest streak since 2020).

We can’t forget the context outside of mortgage rates, either. How confident do you feel about making a major financial decision right now?

Sure, you said a year ago that you’d pounce at the chance to move out of your starter home and buy in that glitzy neighborhood close to that brewery you love. Since then, however, unemployment has risen, hiring has stagnated, and extreme tariffs have become a thing. If you’re wondering about the future of home prices, you have to consider what state the job market is in right now.

This is the nasty double-bind of a housing market stuck in gridlock. If supply won’t pick up, you probably need an economic downturn to bring both prices and rates down. I know it’s the cool new thing to joke about how we need a recession for things to become affordable, but do you really want that?

Recessions are painful for your portfolio, wallet and life. The economy technically shrinks, which causes a chain reaction of all kinds of problems. Job loss, business failures, lower stock prices. It’s an all-consuming affair, and there’s no guarantee you will be spared. If you are, you’re probably too psychologically rattled to make the move (literally).

The housing market is still a difficult topic to talk about. It’s persistently bleak, and somehow getting bleaker.

But I’m an optimistic person, and the cup-half-full side of this housing challenge is that you have options.

If you bought your house in 2023 or later and you’re itching for a lower rate, do the math on how much it would cost you to refinance. If refinancing costs are below what you’d save by changing your rate, then go for it. Just don’t expect the Fed’s rate cuts to solve such a complex problem.

Don’t get too greedy, either. Pick the ideal rate that works for your financial situation, and wait for that rate to materialize. Refinancing bills add up fast.

And if you’re a first-time buyer, godspeed. Your time is coming, if history is any guide.

Thanks for reading!

Callie

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