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The State of Rates

September 27, 2024

The big news this month is the Federal Reserve pivoting to its first interest rate cut in many years, reducing the federal funds rate by half a percentage point to a new range of 4.75%-5.00%.¹ This was the long-awaited shift to lower short-term interest rates.

Additionally, the committee's median projection for the federal funds rate is 4.4% by the end of 2024, 3.4% by the end of 2025, and 2.9% by the end of 2026.² This is excellent news for borrowers, but not such great news for those who like higher short-term interest rates for their savings.

It's worth noting that there is not a perfectly linear relationship between the federal funds rate and longer-term borrowing rates, such as those on mortgages. For example, 30-year mortgage interest rates are more heavily correlated to 10-year U.S. Treasury yields than the federal funds rate.

The red line below shows the effective federal funds rate. The large rise in 2022 was when the Federal Reserve increased the rate significantly to cool inflation. The dip in September 2024 is the latest rate cut.

The blue line indicates the 10-Year Maturity Treasury Bond interest rate.

The green line indicates the average 30-year fixed rate mortgage.

The shaded areas are U.S. recessions.

Chart Source: FRED Chart 2000-01-01 to 2024-09-24

What are the takeaways? We can see that the average 30-year mortgage rate generally follows the 10-year U.S. Treasury Rate, though at times the actual spread can grow and shrink. Also, the 30-year mortgage rate appears to show a loose correlation with the federal funds rate. Hence, the forecast for the 30-year fixed mortgage rate in 2024 and 2025 is expected to decline, but not as much as you may think. See the forecast below:

Table Source: Realtor.com - Experts Predict Where Mortgage Rates Are Headed in 2025 as the Fed Cuts Rates

What is not surprising, is that over 85% of U.S. homeowners with mortgages have an interest rate below 6%.³ That’s a good thing for most people.

However, if you or someone you know purchased a home with a high mortgage interest rate, it’s worth considering the option of refinancing as mortgage rates come down.

One study on the subject, “Why Do Borrowers Make Mortgage Refinancing Mistakes?”⁴ found that the majority of their sample group refinanced sub-optimally due to errors of commission (refinancing at a nonoptimal rate) and errors of omission (refinancing at a later time than optimal). While refinancing earlier could still save you money in the long run, the risk is that you miss the lower optimal rate and/or have to pay additional refinancing costs to refinance again. Likewise, if you wait too long you may miss the lowest rate. This is very similar to the behavioral challenges/errors of timing the stock market.

As a starting point, you should first find out from the lender the costs associated with refinancing, and use a simple refinancing calculator like this one to understand the situation. You should be able to see the break-even point for the upfront refinancing costs versus the lifetime savings on the course of the new loan.

It’s important to remember that many lenders are incentivized to get you to refinance, so you should do so based on your personal circumstances, not just their recommendation!

- Peter Egolf

1. Decisions Regarding Monetary Policy Implementation - Board of Governors of the Federal Reserve System - 9/18/24
2. Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under their individual assumptions of projected appropriate monetary policy, September 2024
3. Redfin - 6 of Every 7 People With Mortgages Have an Interest Rate Below 6%, But the Lock-In Effect Is Starting to Ease
4. Why Do Borrowers Make Mortgage Refinancing Mistakes? Agarwal, Rosen, Yao 2015