Something big is happening in the housing market: What Fed rate cuts will actually do

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On Wednesday, Fed Chair Jerome Powell announced that the central bank would begin cutting Fed interest rates, starting with a .50 percentage point (50 bps) cut this month. The Fed also signaled that additional cuts were likely in their final two meetings this year in November and December, and more next year.

“We have in fact begun the cutting cycle now” Powell proclaimed on Wednesday.

This announcement was expected, given that inflation has decelerated over the past two years, while the job market has cooled, with the unemployment rate rising from the cycle low of 3.4% in April 2023 to 4.2% in August 2024.

Now that the Fed rate cutting is officially here, what does it mean for the U.S. housing market?

While the Fed doesn’t directly set long-term rates and yields, including the 30-year fixed mortgage rate, its policy and the market’s assessment of future rates and the economy do have an impact. We’ve already seen the average 30-year fixed mortgage rate, as tracked by Freddie Mac, decrease from a cycle high of 7.79% in October 2023 to 6.20% as of last week, as financial markets have responded to labor market softening and anticipated Fed rate cuts.

Groups like the Mortgage Bankers Association, Wells Fargo, Fannie Mae, and Moody’s all expect mortgage rates to come down a bit further as the Fed rate cuts remove volatility in the market and as “the spread” narrows.

“I expect the 30-year fixed mortgage rate will be closing in on 6.0% by the end of the year and settle in near 5.5% by the end of 2025,” Moody’s chief economist Mark Zandi tells ResiClub. “The [expected] decline in mortgage rates is due to a narrowing in the spread with the 10-year Treasury yield as the Fed eases policy, the yield curve becomes normally sloped and bond volatility declines, and pre-payment risk normalizes.”

What will happen with existing home sales?

As mortgage rates decline—as we’ve seen in recent months—housing affordability improves. If affordability increases enough and the job market remains stable, it could help ease the “lock-in effect” (homeowners wanting to stay put in homes that are already locked into lower rate mortgage rates) and could lead to more turnover in the resale market.

So far, we’ve only seen a marginal improvement. Mortgage purchase applications, a leading indicator of future home sales, remain low.

However, if mortgage rates stay close to or below 6.0% through spring 2025, it could unlock more new listings. Some homeowners who would otherwise like to sell and buy another home (i.e., those who have been sidelined over the past two years) may find that mortgage rates have finally fallen enough and their life circumstances have shifted sufficiently, making them ready to move on from their 2%, 3%, or 4% mortgage rate.

But even if new listings and existing home sales rise a bit, it doesn’t mean we’ll quickly get back to pre-pandemic existing home sales right away. The recovery could be a grind.

“Although mortgage rates have fallen considerably in recent weeks, we’ve not seen evidence of a corresponding increase in loan application activity, nor has there been an improvement in consumer homebuying sentiment,” wrote Doug Duncan, Fannie Mae’s chief economist, on Wednesday. “We think it’s likely that many would-be borrowers are waiting for affordability to improve even further, and that some may be anticipating additional declines in mortgage rates given expectations that the Fed will lower the federal funds target rate. Others may be waiting for household incomes to improve further to offset some of the recent home price growth, or they may be thinking that future supply growth will ease affordability. Regardless of the lever, we expect affordability to remain the primary constraint on housing activity for the foreseeable future, and we now think full-year 2024 will produce the fewest existing home sales since 1995.”

Fannie Mae’s revised forecast published on Wednesday expects U.S. existing home sales to rise 10.9% in 2025 to 4.51 million.

What about home prices?

On Wednesday, a reporter posed this housing question to Fed Chair Jerome Powell: “Some of your colleagues have expressed concerns that with starting to cut rates you could reignite demand in housing and see [U.S. home] prices go up even more. What’s the likelihood of that and how would you react to that?”

Powell responded, saying: “The housing market, it’s hard to game that out. The housing market is, in part, frozen because of lock-in, lower rates, people don’t want to sell their home because they have a very low mortgage and it would be quite expensive to refinance. As rates come down, people will start to move more and that is probably beginning to happen already. But remember, when that happens you’ve got a seller but you also got a new buyer in many cases. So it is not obvious how much additional demand that would make. The real issue with housing is that we have had, and are on track to continue to have, not enough housing. And so it’s going to be challenging, it’s hard to zone lots in places people want to live. All of the aspects of housing are far more difficult, and where are we going to get the supply? And this is not something the Fed can really fix. But as we normalize rates, I think you’ll see the housing market normalize. Ultimately by getting inflation broadly down and rates normalized and getting the housing cycle normalized, that is the best thing we can do for householders. And the supply question will have to be dealt with by the market, and also by the government.”

Powell didn’t exactly say whether lower rates, and more turnover in the resale housing market, could put upward (or downward) pressure on home prices. He also didn’t rule it out.

The biggest takeaway from Powell’s housing comments on Wednesday was this part: “The housing market, it’s hard to game that out.” In other words, Powell isn’t 100% sure how housing will react.

In ResiClub‘s view, underlying local dynamics in regional housing markets will be the primary driver of home prices. Bifurcation could persist, with prices rising in some housing markets and falling in others. Moving forward, keep a close eye on active listings and months of supply. A significant increase in active inventory suggests cooling on the pricing front, while a sharp decline in active inventory, beyond typical seasonality, indicates tightening and upward pressure on local home prices.

Refinancing is already coming back

The biggest beneficiary so far from the recent drop in mortgage rates is refinancing, as some borrowers who secured 7.0% to 8.0% rates over the past 24 months take advantage of the recent rate dip for some relief.

Here’s the Mortgage Refinance Index reading for the second week of September:

Sept. 2018: 917

Sept. 2019: 2,274

Sept. 2020: 3,289

Sept. 2021: 3,186

Sept. 2022: 533

Sept. 2023: 415

Sept. 2024: 941

“About 4 million homes have a refinance opportunity with rates falling closer to 6% and there are more in the pipeline as the Fed starts the easing cycle” wrote Selma Hepp, chief economist of CoreLogic, on Wednesday.

Beyond an initial burst, the potential for a long sustained boom in traditional refinancing could be limited compared to past booms, given that 76% of outstanding mortgages still have an interest rate below 5.0%.