Why are Mortgage Rates Increasing Despite Federal Reserve Cuts?

Ryaan Zahidani '27

Illustration: Madeleine Armstrong ‘25

In a surprising turn of events, mortgage rates have been climbing despite recent rate cuts by the Federal Reserve. This counterintuitive trend introduces pressing issues for homeowners and other potential buyers, especially Rutgers students, who may wonder why this is happening.  What does this mean for those considering buying a home in the future? 

The Federal Reserve has been cutting interest rates to stimulate economic growth. On September 18, 2024, the Fed lowered its key federal funds rate by 0.50 percentage points for the first time in four years, bringing it to a range of 4.75% to 5.00%. More recently, a second rate cut on November 7, 2024,  brought the target range between 4.50% and 4.75%. These cuts aim to stabilize the economy, prevent a recession, and support a "soft landing" by encouraging more consumer spending and borrowing.

In theory, when the Fed lowers rates, mortgage rates should also drop, making home loans more affordable for potential buyers. However, mortgage rates don't always move simultaneously with the Fed's actions.

While the Federal Reserve's decisions influence the broader interest rate environment, mortgage rates connect more closely to the yields on 10-year U.S. Treasury notes. Both treasury yields and mortgage rates reflect long-term borrowing costs but with one key difference: Treasury bonds are risk-free and backed by the U.S. government. In contrast, mortgages carry more risk due to the possibility of borrower default.

When investors buy 10-year Treasury bonds, they are lending money to the government with guaranteed repayment. But, mortgage lenders are taking on more risk by lending to individual homebuyers, so they typically set mortgage rates higher than Treasury yields. Consequently, mortgage rates tend to rise and fall in line with the yields on Treasury bonds, driven by investor expectations for the economy.

Shawn Dubravac, Chief Economist at the Avrio Institute, explains, “Mortgage rates are particularly sensitive to the yields on longer-term bonds, especially the 10-year Treasury Note.” Unlike the short-term federal funds rate, Treasury yields reflect investors' expectations for the economy over a longer horizon. Various factors influence these yields, including inflation expectations, economic growth, and global interest rate trends (Farrington).

For instance, yields on 10-year Treasuries have climbed over the past few months. As of early November 2024, the yield reached 4.42%, up from 3.69% on the day the Fed cut rates in September. This yield rise signals investor confidence in the economy's strength and expectations of higher inflation. As inflation concerns rise, investors demand higher returns on long-term bonds, which drives up mortgage rates.

Why does this matter? Both Treasury yields and mortgage rates reflect investors' views of the economy. Treasury bonds are virtually risk-free because they are backed by the U.S. government, making them a benchmark for other long-term debt. Mortgage lenders, on the other hand, view home loans as riskier investments. As a result, they add a premium to Treasury yields when setting mortgage rates to account for the increased borrowing costs (such as defaulting).

Now, what does this mean for new or potential homebuyers? For potential homebuyers, rising mortgage rates present a variety of challenges. With higher rates, monthly mortgage payments become more expensive, and the affordability of homes declines. According to NPR, the median price of an existing home in August 2024 was $416,700, about 3% higher than a year earlier. Despite a slowdown in the rapid price increases seen during the pandemic, home prices have remained sticky, making it harder for buyers to find affordable properties (Wamsley).

 There may be better strategies in this environment than waiting for lower rates. As Darren Tooley, a senior loan officer at Cornerstone Financial Services, points out, attempting to "time the market" could lead to higher home prices (Wamsley). As rates eventually stabilize or decline, competition among buyers may increase, pushing home prices even higher.

Moreover, while refinancing may seem like an option for homeowners, it’s less appealing in a higher-rate environment. Homeowners who locked in low rates during the pandemic may find it costly to refinance now, making it essential to weigh the long-term savings against upfront costs.

So, what should buyers do in the current environment? First, it's important to remember that mortgage rates aren’t set in stone. If rates are higher now, buyers can refinance later if conditions improve. It's also worth exploring adjustable-rate mortgages (ARMs), which may offer lower initial rates than fixed-rate loans.

Additionally, buyers might need to adjust their expectations. This could mean reconsidering budget limits, opting for homes in lower price ranges, or increasing their down payment to offset higher interest rates. And while the market may feel slow due to seasonal factors, waiting for a "perfect" time to buy might backfire if home prices rise further.

For Rutgers students looking ahead to homeownership, understanding these trends is important. By learning how interest rates and broader economic conditions affect the housing market, students can better plan for their future financial decisions. Whether they're considering buying a home or pursuing careers in real estate or economics, staying informed will help them make more informed choices. But buyers can still navigate these challenging market conditions by staying flexible, considering different loan options, and being strategic with the right timing.