Rising interest rates have made it increasingly difficult for Americans to check off major life milestones like purchasing a car, starting a business, and buying a home. Over the past two years, the Fed has raised its benchmark rate, or the federal funds rate, to a target range of 5.25% to 5.50%.
Learn more: What prospective homebuyers should know about mortgages.
And the Fed’s rate hikes seem to be working—in June 2022, year-over-year inflation was 9.1%. Now, it’s 3.3%. While inflation has declined, it still remains above the Fed’s 2% target. The Fed had previously signaled three rate cuts later this year, but that now seems unlikely.
In a recent June press conference, the Fed did not indicated when we can expect to see the next rate cut. “The Committee’s assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments,” the Fed announced on June 12.
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How rates are determined—and where mortgage rates currently stand
Your mortgage rate, or mortgage interest rate, is the percentage of your monthly payment you pay to borrow money from your lender for the duration of your mortgage’s term. This rate can be fixed, meaning that it’s locked in and won’t change throughout the life of your loan. Or, it can be a variable rate, which means that it can (and likely will) change in response to larger changes in the market and economy.
The Federal Reserve does not set mortgage rates, these rates are set by individual lenders. However, the Fed does set the federal funds rate, which affects rates on consumer lending products like credit card APRs, savings account APYs, auto loan rates, and even mortgage rates.
Mortgage rates track 10-year Treasuries, which are government bonds with yields that change with the federal funds rate.
The federal funds rate is an interest rate that banks charge other banks when they lend one another money, usually overnight or for a few days. Certain regulations require banks to keep a certain percentage of their customers’ money on reserve, and banks will lend money back and forth to maintain the right level.
When inflation is running high, the Fed will increase rates to increase the cost of borrowing and slow down the economy. When it’s too low, they’ll lower rates to increase demand and stimulate the economy.
Several factors influence mortgage rates. On a macro level, mortgage rates tend to increase or decrease in response to the overall health of the economy, the inflation rate, the unemployment rate, and other key economic indicators. On a micro level, rates will vary from lender to lender and your own financial stats. A mortgage is a loan, and your lender assumes a certain level of risk by loaning you that money depending on your income, credit score, employment situation, and debt.
As of the date of this article being updated, the average rate for a 30-year fixed-rate mortgage stands at 6.98%, according to Mortgage News Daily, while the average rate for a 15-year fixed-rate mortgage is 6.40%.
What happens when the Fed increases or decreases interest rates
The FOMC evaluates various key economic indicators when deciding whether to raise or lower rates. One key signal is the inflation rate. According to the Fed, a 2% inflation rate is the sweet spot for maximum employment and price stability. In 2022 and 2023, the Fed acted aggressively to tame rising inflation, boosting rates 11 times over the course of more than a year.
The string of consistent interest rate increases prompted mortgage rates to rise steadily in 2022 and 2023, exceeding pre-pandemic levels after hitting record-lows at the start of the pandemic. Now, mortgage rates have begun to decline slightly as a result of the Fed’s announcement that it would cut rates three times this year.
5 moves to make if you’re preparing to buy a home right now
If you’re planning on becoming a homeowner this year, you’re at the mercy of the lenders who will decide whether or not to approve you for a mortgage. However, there are moves you can make to position yourself better to secure the best possible rate—even in an high-interest rate environment.
- Work on improving your credit score. The higher your credit score, the better chance you have of securing a mortgage with a more favorable rate. Be sure to consistently pay bills, debt, and other monthly payments on time. If you haven’t checked your credit score in a while, you should aim to do so before embarking on the homebuying process. If your score is lower than you anticipated, request a free copy of your credit report from one of the three major credit reporting bureaus and comb through it to see if there are any factors or possible errors that could be dragging your score down.
- Shop around for the lowest rate. This may seem like a no-brainer, but take your time and compare rates from multiple mortgage lenders. Many offer free quotes online or by phone after you’ve answered a few key questions about your credit score range, loan amount, loan type and term. This is just an estimate and won’t give you a completely accurate rate, but it will give you a ballpark idea of what kind of rate you may be able to secure from each lender. Once you’ve narrowed your list down, the lender you choose will thoroughly vet you and your financials during the preapproval process through a hard credit inquiry that will help them determine how much you’re qualified to borrow.
- Save up for a larger down payment. Typically, a larger down payment will help you secure a lower interest rate. The larger your down payment, the less money you have to borrow overall and the less you’ll pay in interest over time. Ideally, you should strive to have 20% of your home’s purchase price set aside for a down payment, but for many homeowners, and especially first-time home buyers, this can be a stretch. After you’ve shopped around and taken a look at the rates various lenders are offering you, revisit your personal budget to determine how you might save a little extra for your down payment to reduce your overall borrowing costs and secure a lower rate. Even a fraction of a percentage point can translate to major savings over the life of your loan. You can also supercharge your savings and grow your down payment with the help of an interest-earning savings vehicle like a certificate of deposit or high-yield savings account.
- Think carefully about your loan term. Selecting a longer loan term can free up room in your budget to hit more immediate goals, but it will also come with a higher interest rate. If you have room in your monthly budget to pay more each month, you might consider opting for a loan with a shorter repayment term to reduce how much you pay in interest over time and eliminate your debt a lot sooner.
- Be sure to lock in your rate. Mortgage rates are sensitive to a number of external factors, and as such you could benefit from a mortgage rate lock, also known as rate protection. Lenders offer this (sometimes for an additional fee) to help you lock in the interest rate you’re offered during the homebuying process to keep your interest rate from increasing between the time you apply for a mortgage and your closing date. Warning: even if your rate is locked, it can still change if there are changes in your application—including your loan amount, credit score, or verified income.
The takeaway
With rate cuts expected later in 2024, mortgages could become more affordable in the coming year. However, for some consumers, it may be difficult to time their home-buying decisions around when the Fed will cut rates. Regardless of what the Fed does, improving your credit score, setting clear savings goals, and shopping around for the lowest mortgage rate can help you save some money when you buy a home.
About the contributors
Ivana Pino is a personal finance expert who is passionate about creating inclusive financial content that reaches a wide range of readers from all types of backgrounds. She graduated from the S.I. Newhouse School of Public Communications at Syracuse University with a degree in Digital Journalism.
Trina Paul covers all subjects related to personal finance, from bank deposit products and credit cards, to investing. Her bylines can also be found at CNBC Select and the Skimm. She graduated from Swarthmore College with a degree in economics.
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