The Federal Reserve has raised interest rates for the eighth time in eight meetings. This time, though, the hike is smaller: Fed Chairman Jerome Powell announced a quarter-point increase in the federal funds rate Feb. 1, which is down from the half-point increase at the previous meeting and the three-quarter-point hikes of 2022.

And that has housing economists breathing a sigh of relief. “The second half of 2022 was a housing market recession,” says Mark Fleming, chief economist at title insurer First American. “But the worst is behind us.”

In an effort to rein in raging inflation, the Fed boosted interest rates by a quarter-point in March 2022, then by a half-point in May. It raised them even more in June, by three-quarters of a percentage point — which was, at the time, the largest Fed rate hike since 1994 — and went on to do the same in July, September and November. December’s increase was a half-point.

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, since late summer the housing market has shown signs of cooling. Home sales have dropped sharply, and appreciation slowed nationally, with home prices dropping in many markets. And home prices are driven not just 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/or lower offers for their homes. But mortgage rates have cooled since topping 7 percent last fall. As of Bankrate’s national survey Feb. 1, the average rate on a 30-year mortgage was 6.3 percent.

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.

Still, the Fed’s policies set the overall tone for mortgage rates. Mortgage 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’s December rate hike was the seventh bump in 2022, a year that saw mortgage rates swing wildly 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, assistant research economist at the Texas Real Estate Research Center at Texas A&M University.

But with home prices stabilizing and mortgage rates falling, the affordability squeeze is easing a bit. The Mortgage Bankers Association predicts rates could fall to the low 5 percent range by the end of 2023.

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. Economists expect price declines of anywhere from a few percentage points to more than 20 percent.

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 higher than they are today — and prices soared.

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

But with mortgage rates pulling back, affordability is less of a factor. For instance, borrowing $320,000 at last year’s peak rate of 7.12 percent translated to a monthly payment of $2,154. Taking a mortgage for the same amount at this week’s rate of 6.3 percent means a monthly payment of $1,980 — a difference of $174 a month.

Next steps for borrowers

Here are some tips for dealing with elevated mortgage rates from Greg McBride, CFA, Bankrate’s chief financial analyst:

  • 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 are growing more 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,” McBride 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) for tapping home equity.