This past Wednesday, the Federal Reserve Bank reduced the Fed funds rate by .5%, bringing it's target rate to 4.75-5% from the previous 5.25-5.5% range. But what does the Fed rate cut mean? To the vast majority of people not dealing directly with the Fed?

It's important to understand what the Fed funds rate actually is in order to understand what it does. The Fed funds rate is the rate at which banks borrow from each other and from the Fed. So if the Fed is lending to a bank at (for example), 5%, the bank will add a margin to that money to lend to consumers - so, for example, if a bank has a 2% profit margin, the rate a consumer might receive would be 7% (the bank margin, plus the rate the bank has to pay the Fed for the money they're borrowing). This is one way banks and the overall market maintain liquidity.

A Fed rate cut is designed to either increase economic activity through consumer spending and borrowing (more people are more likely to borrow and spend when money is cheaper), or to help prevent too much of an economic slowdown from a previously more restrictive Fed stance (aka, what we're seeing today - the Fed sees inflation falling, and the job market showing signs of weakness, so the current round of cuts is in hopes that they'll help the economy just enough to avoid a recession without re-stimulating inflation).

What Does the Fed Rate Cut Mean For Mortgage Rates?

When it comes to mortgage rates, the Fed rate cut (or increase) announcements usually have minimal, if any, impact. The reason is that the economic conditions which influence the Fed decisions are usually known in advance, and therefore already factored into the market. We can use the September 18 Fed rate cut as an example - the market has already seen inflation trending downward, and has recently revealed some very shaky jobs numbers in the monthly BLS jobs report. When that economic data is released, the market reacts, knowing that the same data is likely to influence Fed rate policy. Therefore, the only time Fed rate decisions have a big impact on the market is if the decision is different from what the market expects (the market expected a 50 basis point/.5 cut, and since that's what happened, rates and the markets didn't budge too much - had the Fed only cut .25, we'd have likely seen mortgage rates jump higher, and if the Fed cut .75, mortgage rates likely would have fallen as it would have been a signal that the overall economy is in worse shape than previously thought).

So while the Fed rate decisions don't directly impact the market, the Fed rate is a direct result of the same market movements and economics that do directly influence mortgage rates. It's more important to know the direction the Fed will head in the future than it is to see their actual rate decision when it comes to predicting home loan rates.

Are Mortgage Rates Falling?

Yes, mortgage rates have come down nicely from the near-8% highs seen as recently as July, but the rates are coming down not because of what the Fed has done, but because of what the economy has done. Since mortgage bonds are typically longer term financial securities, they perform better when inflation is low (to simplify: if money is worth less in the future, then a fixed dollar amount like what investors receive when they offer a 30 year fixed mortgage needs to come with a higher % to make the long term investment worthwhile. Whereas, if money is expected to stay cheap/inflation is expected to come down or remain low, investors can demand a lower % on a longer term investment).

How Low Will Mortgage Rates Go?

That depends largely on the economy. The Fed needs to be careful because if they cut too much too soon, it could bring back inflation, leading to rate increases. But if they cut too little for too long, the economy could dip into recession and we could see a large spike in unemployment around the country. It's a fine line the Fed walks, because they rely on data coming in from previous months to make their decisions rather than relying on nearly-impossible-to-get (accurately, at least) real time data.

Every economist has different predictions, but I don't think it's impossible for rates to get down into the 4% range based on historical data and several factors I won't get into here for the sake of brevity. So should you consider getting a loan today, or should you wait? It's important to remember, economic cycles don't happen overnight. The last few economic cycles have lasted ~2 years, so if a refinance or mortgage loan would help you save money today, you can opt for taking out a loan and very likely have another opportunity to further reduce the interest rate on that loan before the Fed moves once again to a rate hiking cycle.

It is important to remember though, that in a cycle where rates are falling, it's often a smarter move to limit up front costs on a loan than it is to get the lowest rate? Why? Well let's look at an example - if you're considering a refinance to save $200/month, but the loan costs you $5,000 in total costs, you'd need to have that loan for 25 months before the savings break even with the cost. If you compare that to a loan where you save $100 but the cost is just $1,000 total, you'd only need to carry the loan for 10 months to break even. So if you believe rates will continue to head down, it's smarter for most people to pay less up front cost at the expense of getting the lowest rate possible - because interest rates being offered today (some with very high loan costs) are very likely to be available for less money (or for FREE), before long.

Any questions on the Fed rate hike, what the Fed rate hike means, or anything else mortgage or real estate related? You can always reach out for a super fast response by asking an expert here!

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