Lower mortgage rates mean increased purchasing power

At the time of writing this article (October 2024), the Fed had made its first rate cut, cutting rates by 50 basis points (0.5%) on September 18, 2024 — but rates had actually slightly risen immediately after that rate cut. That rise is not expected to be the trend.^Footnote1

All the major prognosticators expect the same trajectory for mortgage rates in 2025 — a slow, gradual drop. Both Fannie Mae (Federal National Mortgage Association) and NAR (National Association of Realtors) predict that mortgage rates will reach an average of 6% in Q1 of 2025, 5.9% in Q2, 5.8% in Q3, and Fannie Mae predicts 5.7% in Q4, while NAR sticks with 5.8% for that final quarter.^Footnote1

Of course, market volatility is a fickle beast, and these forecasts could end up missing the mark. Regardless, the experts agree that the drop in mortgage rates will not be speedy or drastic. Reaching pre-pandemic lows is unlikely, and reaching historic sub-4% rates again is virtually impossible without an economic crisis.

If the labor market, or the economy at large, were to slow down rapidly or enter a recession, the Federal Reserve could respond with interest rate reductions that might lead to mortgage rates dropping more quickly than predicted.^Footnote2

As rates drop, home prices typically tend to rise, though that rise in prices tends to happen more slowly than the drop in rates. So, potential homebuyers who have all their ducks in a row and are ready to purchase as soon as the rate is right for them will likely be able to get in before the subsequent rise in home prices.

If mortgage rates do drop to 6%, that would be 1.79% lower than their October 2023 peak of 7.79% — the highest rates had reached in over two decades. As the graph shows, even a 1.5% dip in mortgage rates from 7.5% to 6% translates to a $266 reduction in the monthly mortgage payment on a $400,000 home. For prospective first-time homebuyers who are right on the cusp of affording a home, that $266 per month could mean the difference between buying and waiting.^Footnote2

Similarly, as stated in the intro, that same dip in rates from 7.5% to 6% adds $74,293 in purchasing power for homeowners with a $2,500 monthly mortgage payment. The additional quality in the homes now in a prospective buyer’s price range could be the enticement that leads some homeowners to put their homes up for sale and move on to greener pastures.

There are two mortgage options that can bring the mortgage rate down even further: 15-year mortgages and adjustable-rate mortgages.

15-year mortgages often offer rates half a percent to a full percent lower than their 30-year counterpart. Of course, the truncated time frame means the monthly payments are considerably higher, but the money saved in interest over the life of the loan will be at least in the tens of thousands.^Footnote3

An adjustable-rate mortgage, or ARM, typically offers a slightly lower interest rate as well. If a homebuyer chooses an ARM with a fixed rate for the first five years, they can enjoy the savings of the lower rate, and then refinance before that five-year period ends and the loan switches to an adjustable rate. This is also a good option for homebuyers who intend to live in their home for less than five years.

A significant portion of homebuyers who purchased their homes between October 2023 and October 2024 have mortgage rates above 7%. If rates drop to 6% or lower, refinancing their loans would decrease their monthly mortgage payments by hundreds of dollars (around $200 for a $400,000 mortgage, as shown in the illustration). So, it’s possible that lenders will see an influx of refinance requests as rates hit 6% and lower.

The caveat, of course, is that the homeowner will need to pay closing costs on the new mortgage, and it will take a few years for the lower monthly payment to make up for that expense, so a refinance is not the right move for someone who isn’t planning to stay in their home for at least five years.