I recently spoke with a couple who were looking to sell their home. Their real estate agent told them the market was a little soft, but added that interest rates were likely to drop this year. The suggestion is that falling interest rates will push up house prices. This is a common assumption, but it makes me wonder if it's always true.
There are two key questions worth asking here. First, when the Fed cuts interest rates, do mortgage rates necessarily fall? Second, even if mortgage rates fall, should we expect home prices to rise as a result?
To help answer these questions, I spoke with Eric Steuernagle, owner and housing expert at Fairground Real Estate in Great Barrington, Massachusetts. I also reviewed decades of interest rate and house price data.
Federal funds and mortgage rates
The Federal Reserve directly controls the short-term interest rate known as the federal funds rate. This rate is what banks charge each other for overnight lending, so it's quite different from the rate you'd pay on a 30-year mortgage. Mortgage rates are more closely tied to long-term rates, which are affected by inflation, investor expectations, housing demand and even global events.
Nonetheless, historical data shows that short-term and long-term rates generally move in the same direction. Since the late 1980s, the average spread between the Fed's target rate and the 30-year mortgage rate has been about 3 percentage points (see Figure 1). So if the Fed's rate drops to around 3.5%, mortgage rates could stabilize around 6.5% – roughly where they are today.
That's one reason Stuernagel is skeptical that housing prices will fall significantly. “If you think house prices might go up,” he said [mortgage] Interest rates will return to 2.75% [where they were at the beginning of the pandemic]but this may be a once in a lifetime experience. “
The Federal Reserve lowered the federal funds rate by 0.25 percentage points in September and October respectively. The market still expects another 0.25 percentage point interest rate cut this year, but uncertainty remains. The goal is to stimulate the economy amid signs of labor market weakness. So while a Fed rate cut may result in a small decrease in mortgage rates, there's no guarantee that rates will fall significantly.
Historical data suggests that when the Fed lowers overnight lending rates, long-term interest rates, including mortgage rates, are likely to fall slightly. But as far as Steuernagle is concerned, mortgage rates between 5% and 6% are far less attractive to buyers than the 3% rates we saw a few years ago.
Mortgage rates and home values
Even if mortgage rates do fall, the bigger question is what that means for home prices. In theory, lower mortgage rates make monthly payments more affordable for buyers, which should support higher home values. But history shows that this link is far from consistent.
Consider the four major rate-cutting cycles in recent decades:
- Early 1990s (Gulf War Recession): Between 1990 and 1993, mortgage rates fell from about 10% to 7%. However, house prices have barely budged, rising by just 2% in four years.
- Early 2000s (dot-com bubble burst): Between 1999 and 2003, house prices fell from around 8% to 6%. This time, house prices soared, rising by about 40% nationwide.
- 2007-2008 (global financial crisis): Interest rates fell from about 6% to 5%, but as the housing market collapsed, home prices plummeted, falling 17%.
- 2019-2020 (COVID-19 pandemic): Mortgage rates fell from about 4.5% to a record low of 2.7%. Home prices soared 14% and have continued to climb ever since.
The lesson from these events is that economic factors such as job losses, stock market performance and financial crises can overwhelm the impact of lower interest rates. It’s also important to remember that the real estate market is highly localized. Taxes, job opportunities, school quality and community factors all affect affordability and demand in ways that national rates cannot fully explain. In fact, Sturnagel said taxes and other local factors may be more relevant when assessing affordability.
Home Value Bottom Line
It's reasonable to expect mortgage rates to fall in response to the Fed's rate cuts, but that doesn't mean home prices will automatically rise. If anything, broader economic trends and local market dynamics will play a bigger role than Fed policy alone.
Luke Delorme, CFP® is the Director of Financial Planning at Tableaux Wealth in Great Barrington, MA (www.tableauxwealth.com), reachable luke@tableauxwealth.com. To stay up to date on the Squared Away blog, join our free email list.
This blog post is for informational and educational purposes only and should not be construed as financial advice. Please consult a qualified professional for advice specific to your situation.
