Earlier in the inflationary cycle, the Fed had enacted increases of as much as three-quarters of a point. Now that inflation is down to 3.7 percent — not far off from its official target of 2 percent — some housing economists think we may be near the end of this round of tightening. “If the Fed does indeed move to cut rates next year and signals its intent to do so, mortgage rates should trend downward,” says Mike Fratantoni, chief economist at the Mortgage Bankers Association. “Our forecast calls for this to happen, which would support a somewhat stronger spring housing market.”

In an effort to rein in inflation, the Fed boosted interest rates by a quarter-point in March 2022, then by a half-point in May 2022. It raised them even more in June 2022, by three-quarters of a percentage point — which was, at the time, the largest Fed rate hike since 1994. The hikes aimed to cool an economy that was on fire after rebounding from the coronavirus recession of 2020. That dramatic recovery has included a red-hot housing market characterized by record-high home prices and microscopic levels of inventory.

However, for months now the housing market has shown signs of cooling. Home sales have dropped sharply, and appreciation slowed nationally, with home prices dropping in many previously overheated markets before starting to climb again in mid-2023. Home prices are not driven solely by interest rates but by a complicated mix of factors — so it’s hard to predict exactly how the Fed’s efforts will affect the housing market.

Higher rates are challenging for both homebuyers, who have to cope with steeper monthly payments, and sellers, who experience less demand and lower offers for their homes. After topping 7 percent last fall, mortgage rates dipped back down slightly, then came roaring back. As of Nov. 1, the average 30-year rate stood at 7.95 percent, according to Bankrate’s national survey of lenders — near a 23-year high.

How the Fed affects mortgage rates

The Federal Reserve does not set mortgage rates, and the central bank’s decisions don’t move mortgages as directly as they do other products, such as savings accounts and CD rates. Instead, mortgage rates tend to move in lockstep with 10-year Treasury yields.

A slowing economy and an easing of inflation pressures are the prerequisites for lower mortgage rates. — Greg McBride, Bankrate Chief Financial Analyst

“Mortgage rates don’t take direct cues from the Fed and will instead respond to the outlook for the economy and inflation,” says Bankrate chief financial analyst Greg McBride. “A slowing economy and an easing of inflation pressures are the prerequisites for lower mortgage rates.”

Still, the Fed’s policies set the overall tone for mortgage rates. Lenders and investors closely watch the central bank, and the mortgage market’s attempts to interpret the Fed’s actions affect how much you pay for your home loan. The Fed bumped rates seven times in 2022, a year that saw mortgage rates jump from 3.4 percent in January all the way to 7.12 percent in October before inching back down again. “Such increases diminish purchase affordability, making it even harder for lower-income and first-time buyers to purchase a home,” says Clare Losey, an economist at the Austin Board of Realtors in Texas.

How much do mortgage rates affect housing demand?

There’s no doubt that record-low mortgage rates helped fuel the housing boom of 2020 and 2021. Some think it was the single most important factor in pushing the residential real estate market into overdrive.

Then, in late 2022, mortgage rates surged higher than they had been in two decades, and the housing market slowed dramatically. While sales volume remains slow, prices are volatile: Home prices declined for seven straight months through January 2023 but have now risen for another seven straight, according to the Case-Shiller U.S. National Home Price NSA Index. And the nationwide median existing-home price for September was $394,300, according to the National Association of Realtors  — the highest September median NAR has ever recorded.

Yet, in the long term, home prices and home sales tend to be resilient to rising mortgage rates, housing economists say. That’s because individual life events that prompt a home purchase — the birth of a child, marriage, a job change — don’t always correspond conveniently with mortgage rate cycles.

History bears this out. In the 1980s, mortgage rates soared as high as 18 percent, yet Americans still bought homes. In the 1990s, rates of 8 percent to 9 percent were common, and Americans continued snapping up homes. During the housing bubble of 2004 to 2007, mortgage rates were high, yet prices soared.

So the current slowdown may be more of an overheated market’s return to normalcy rather than the signal of an incipient housing crash. “The combination of elevated mortgage rates and steep home-price growth over the past few years has greatly reduced affordability,” Fratantoni says.

But if mortgage rates pull back, affordability will become less of a factor. For instance, borrowing $320,000 at the early November rate of 7.95 percent translates to a monthly principal-and-interest payment of $2,337. Taking a mortgage for the same amount at February’s rate of 6.3 percent meant a monthly payment of $1,980 — a difference of $357 a month.

Next steps for borrowers

Here are some pro tips for dealing with elevated mortgage rates:

  • Shop around for a mortgage. Savvy shopping can help you find a better-than-average rate. With the refinance boom considerably slowed, lenders are eager for your business. “Conducting an online search can save thousands of dollars by finding lenders offering a lower rate and more competitive fees,” McBride says.
  • Be cautious about ARMs. Adjustable-rate mortgages may look tempting, but McBride says borrowers should steer clear. “Don’t fall into the trap of using an adjustable-rate mortgage as a crutch of affordability,” he says. “There is little in the way of up-front savings, an average of just one-half percentage point for the first five years, but the risk of higher rates in future years looms large. New adjustable mortgage products are structured to change every six months rather than every 12 months, which had previously been the norm.”
  • Consider a HELOC. While mortgage refinancing is on the wane, many homeowners are turning to home equity lines of credit (HELOCs) to tap into their home equity. The rationale is simple: If you need $50,000 for a kitchen renovation and you have a mortgage for $300,000 at 3 percent, you probably don’t want to take out a new loan at upwards of 7 percent. Better to keep the 3 percent rate on the mortgage and take a HELOC — even if it costs 8 percent.