Why are mortgage rates so high? When mortgage rates come back down?
For many people, the mortgage payment is the largest line item in their budget. And for anyone that has bought a home over the last couple of years, that has felt that even more. More people continue to buy houses for various reasons so more and more people are being exposed to these high mortgage rates. So this leads people to ask, when will they come back down?
No one really knows the answer but the short answer is that we likely wont see rates in the 2’s or low 3’s anytime soon, if ever again. According to the Federal Reserve Bank of St. Louis the average mortgage rate nationwide(as of July 3rd) is 6.95%. So is that good? Well if you look back historically, it is in line with what we have seen. Much of the 80’s and 90’s was spent with mortgage rates over 7%.
So how did we get here? If we look at the chart below of the fed funds rate, you will start to see a very similar path to the chart above. The chart below is the Federal Funds effective rate.
The federal funds rate is determined by the Federal Open Market Committee. This group meets throughout the year to determine the appropriate fed funds rate based on economic conditions. Rather than go into details on this I will keep it high level. The fed tries to keep the economy from getting too hot or too cold and they have a few different tools at their disposal to try to accomplish that. One of the tools is raising or lowering the fed funds rate. So, if the economy heats up they raise the interest rates to slow it down and if the economy cools down they lower rates to heat it back up, or jump-start the economy.
So why have rates been so low in the last 20 years? We have had three major economic shocks. You can see on the charts when the rates when low to combat those major economic crisis. The 2000 tech bubble, the ’08 financial crisis, and the covid pandemic. The Fed has used a lot of its tools to try to stimulate the economy over the last 20 years and one of them is keeping the Fed funds rates at historically low levels. You can see that in the chart above. Rates were cut much lower in the last 20 years than they were cut in the past.
Many recent years have been spent at or near 0% fed funds rate and all other interest rates flow from the fed funds rate. There is a little bit of nuance to it but broadly speaking, if the fed funds rate is low, mortgage rates will be lower and if the fed funds rate is higher, then mortgage rates will be higher. But they are different interest rates.
This leads to the final question, will this change anytime in the near future? As I stated previously, its hard to imagine getting back to some of the low mortgage rates we saw a few years ago. Those are the lowest rates we have ever seen so you should not base your financial plan on being able to refinance at those low rates again in the future.
Unless there is a major economic shock coming, the interest rates will come down slowly. The Fed seems to be trending towards one possible cut in 2024. They could do more but there are only four FOMC meetings left this year so its unlikely there would be more than one or two additional cuts. Then they may have some additional cuts in 2025. But these will be slow and methodical, not rapid cuts like we got during the covid pandemic.
The bottom line, there is a good chance of lower mortgage rates in 2025 and 2026 but it may not be substantially lower so plan accordingly. Only buy a house you can afford within this current rate environment. It is dangerous to overbuy thinking you will be able to refinance to a lower rate soon. Anticipate that mortgage rates wont drop to a level that is worth it to refinance for quite some time. If it happens sooner you can absolutely refinance, but please don’t buy a house that you must refinance in order to afford long term.
God Bless,
Phil Francois, CFP®