How a Fed Rate Drop Affects Home Buyers and Sellers

Introduction to the Fed rate drop

It’s a persistent myth that the announcement of a Fed rate drop pushes mortgage rates lower. Often, such an announcement has the opposite effect, sending those rates higher.

For example, when the Fed implemented a rate cut in December 2024, mortgage rates actually increased by about 20 basis points, despite the quarter-point (25 basis points) reduction.

While the Federal Reserve has a significant influence on mortgage rates, most of the impact occurs before an official announcement is made. By the time a rate cut is publicized, much of the change is already reflected in the market.

What is a Fed rate drop?

But first, we need to understand what a Fed rate drop is. It’s all to do with “monetary policy.” The Fed itself defines that as:

“Monetary policy in the United States comprises the Federal Reserve’s actions and communications to promote maximum employment, stable prices, and moderate long-term interest rates — the economic goals the Congress has instructed the Federal Reserve to pursue.”

As a result of supply chain bottlenecks caused by the pandemic and Russia’s invasion of Ukraine, prices in America rose steeply in the early 2020s. And, because inflation is so corrosive, the Fed raised its interest rate sharply, causing most borrowing costs to rise.

The rate of price rises then slowed. It increased by only 2.4% (year-over-year) in November 2024, which is close to the Fed’s target of 2% a year.

Worse, price rises had stubbornly stayed above the Fed’s ideal for many months. Given that unemployment was low and the economy was thriving, the Fed decided to go ahead with their December cut but to reduce the number of cuts it was forecasting it would make this year.

That, it figured, gave it a good chance of slowing price rises further without harming employment or economic growth too much.

How mortgage rates are determined

The Fed doesn’t set mortgage rates. They’re determined by yields in a specialist bond market in which mortgage-backed securities (MBSs) are traded.

The investors who trade in MBSs are certainly influenced by the Fed’s monetary policy. But they are on a different timetable from the rest of us.

They trade (wager, if you’re uncharitable) ahead of events based on what they expect to happen. On Dec. 18, they had already traded in anticipation of the quarter-point rate cut. That meant that day’s rate reduction was already priced into mortgage rates, which didn’t move on the news.

So, what did push mortgage rates higher that day? The Fed published its quarterly summary of economic projections. And that showed it was now planning only two rate cuts throughout 2025, down from the four previously penciled in.

Remember how MBS investors trade ahead of events based on what they expect to happen? Well, the Fed’s new cuts forecast really messed with their expectations, and mortgage rates shot up.

How a Fed rate drop affects home buyers

So, a Fed rate drop may or may not immediately affect home buyers, depending on whether it’s expected by MBS investors. The announcement of an unexpected (or unexpectedly large) cut might easily cause mortgage rates to tumble.

The trouble is, those are relatively rare. In recent years, the Fed has gotten much better at signaling its intentions to markets in advance of announcements.

But those signals can help mortgage rates a lot. When senior Fed officials are being “doveish” (talking up the chances of further rate cuts), mortgage rates typically fall. But, when they’re being “hawkish” (talking down those chances), those rates often rise.

So, Fed rates policy certainly does help or harm mortgage rates. But often before a hike or cut is formally announced.

Benefits of lower mortgage rates for homebuyers

Is the Fed dropping rates again in 2025? There’s a good chance it will come about.

However, the new administration has many novel economic policies, and economists disagree on whether they’ll help or hinder the economy. So, we’ll have to wait to see how things pan out.

Lower mortgage rates certainly bring many advantages to home buyers. They typically lead to lower monthly payments. Or, you may prefer to keep your payments high and buy a more costly home than you could otherwise afford.

But the benefits are rarely unalloyed. It won’t just be you who’s out there wanting to buy a home.

There’s currently huge pent-up demand, and your local property market might be flooded with people wanting to buy. That can drive up home prices and mean it takes longer for you to find a home that hasn’t already been snapped up.

What’s realistic?

But we may be getting ahead of ourselves. Expert opinions are mixed on whether we can expect mortgage rates to drop far in 2025 and ‘26. In fact, The Mortgage Reports has its own mortgage rate predictions, which you should check out for a detailed outlook.

For example, the Mortgage Bankers Association’s January 2025 forecast thinks rates for 30-year, fixed-rate mortgages (FRMs) will average 7% in the first quarter of 2025, inching down to 6.5% by the fourth quarter, and then sticking at 6.4% throughout 2026 and 2027.

Fannie Mae is only a bit more optimistic. Its most recent forecast shows 30-year FRMs averaging 6.4% in 2025 and 6.1% in 2026.

Of course, these are just forecasts and may well be proved wrong. But, if you’re holding out for mortgage rates beginning with a 5 or 4, you’d better settle down for a long wait.

If your current mortgage payments are causing you problems, read How To Lower Your Mortgage Payment | 2025

How a Fed rate drop affects home sellers

If Fannie and the Mortgage Bankers Association are correct, then things will likely ease only a little during 2025 and ‘26. Still, even a slight improvement is far more welcome than a slight decline.

And even a small reduction in mortgage rates can bring more aspiring home buyers into the market. That’s especially true if those buyers realize more significant rate cuts aren’t on the horizon.

Increased competition means more buyers, which usually results in higher prices. Better yet, your chances of selling your home quickly get better, though only if you price your home appropriately.

So, a sellers’ market can be a joy for existing homeowners. However, most of those go on to buy another home.

And then they see the market from the other side. So, make sure you have advanced plans for your purchase before you commit to a sale.

Finally, bear in mind that markets naturally want to be in equilibrium. More sellers might soon enter the market, increasing the supply of existing homes.

And developers may be attracted by the higher prices, building new homes. So, take advantage of your window of opportunity before it closes.

Impact on the housing market

“The construction and housing industry is a major contributor to the American economy and gross domestic product (GDP),” says Kiplinger. “Lower interest rates will give it life again as this will likely create more homebuyers and demand, more incentives for developers and thaw a static market with few buyers and sellers.”

There’s no doubt that significantly lower mortgage rates can have a profound effect on housing markets. However, right now, experts are forecasting only modest falls.

Our best hope for much lower mortgage rates is that the Trump administration’s policies confound doubting economists by driving inflation lower and creating an environment in which the Fed can cut its rate more often and more decisively.

On the campaign trail, President-elect Donald Trump promised 3% mortgage rates. Many are skeptical that he can deliver on that. But imagine the impact on the housing market if he can!

What buyers and sellers should do to prepare

Buyers

As soon as you can, start to get your finances into the best shape possible. Focus on your credit score and debt burden (your debt-to-income ratio).

Boosting your credit score and reducing your monthly debt payments can earn you a more competitive mortgage rate. Start by reducing your credit card balances to below 10% of their credit limits. That helps both.

Before you begin actively hunting for a home, research the mortgage market and find a lender that seems to suit you. Ask for a mortgage preapproval.

This will tell sellers and agents that the lender has checked out your credit and financial situation and is willing to lend you $x in principle. Without an official preapproval letter, there’s no way to distinguish you from someone who isn’t financially prepared to buy a home.

Sellers

Before listing your home, make it as marketable as possible. Just don’t spend a lot of money. Major projects rarely pay for themselves in the short term.

Add curb appeal by making your front yard as neat and colorful as the season allows. And replace, repair or redecorate cracked sidings and panes, slipped tiles and flaky paint.

Inside, undertake a deep clean, making sure any lingering smells are banished. Freshen up tired rooms with new paint in neutral colors. Declutter by putting knickknack, oversized furniture and any excess books into storage. Consider minor, inexpensive, cosmetic upgrades to the kitchen and bathrooms.

Once you’re ready to list, take great care over pricing. Talk it over with your real estate agent and respect his or her advice, even if you don’t take it. It’s better to sell for above the asking price than to scare off buyers with one that’s too high.

The bottom line

A Fed rate drop normally does affect mortgage rates but not necessarily on the timetable you might expect. By the day on which one is announced, the movement has already happened because markets are expecting it. Only surprise cuts or hikes tend to change mortgage rates on the day.

Significant falls in mortgage rates are currently looking unlikely over the next two or three years. However, those with faith in the Trump administration may hope that his policies will change that outlook.

If appreciably lower mortgage rates do materialize, that could transform housing markets, benefiting both buyers and sellers.