After more than a year of stubbornly high mortgage interest rates, a glimmer of light may just be emerging at the end of the tunnel. Last month, the average rate on a 30-year fixed-rate mortgage dropped below 6.5% for the first time in 15 months, and there's reason to be optimistic that rates may continue to drop.

How mortgage rates are determined

Mortgage rates are set by lenders, and vary based on many factors, including economic conditions and the credit profile of the individual borrower. However, one of the primary factors is the benchmark rate set by the Federal Reserve, which essentially sets the baseline cost of borrowing money in the U.S. In general, when the Fed's benchmark rate goes up or down, average mortgage rates (and other loan interest rates) go up or down proportionally.

One of the Fed's primary objectives is to control inflation, and the benchmark rate is the mechanism it uses to do so. When inflation began to accelerate in early 2021 on the heels of the COVID pandemic, the Fed responded with a series of benchmark rate hikes, causing average market rates to climb from historic lows to 20-year highs over the course of less than two years.

For more than a year, average mortgage rates have hovered near 7% as a direct result of this anti-inflationary monetary policy. However, as recent economic data shows inflation potentially cooling off, the Fed appears poised to cut the benchmark rate for the first time in years. In comments at the annual Jackson Hole Economic Symposium in August, Fed Chairman Jerome Powell stopped short of guaranteeing a rate cut, but said that "the time has come for policy to adjust" in response to slowing inflation. In response to these comments, lenders have already started to reduce their rates, and analysts are united in their expectations of cuts to the benchmark rate, beginning as soon as September.

How low will rates go, and how soon?

When the Fed does begin to cut its benchmark rate, it is likely to do so gradually. Estimates vary, but the general expectation is that the first cut will be in the range of 25 basis points (or 0.25%). Assuming continued cooling of inflation, further cuts could follow - also likely in small increments.

Even with cuts expected in the near term, very few analysts expect average market rates to dip below the high 5s before the end of 2025. The one situation that could lead to a more rapid drop in rates is a recession, which brings with it plenty of issues on its own.

The bottom line - the upward march of interest rates seems to be at its end, and a gradual descent can be expected over the next year and beyond.

What it means for those in the housing market

For prospective buyers, this is welcome news - although rates may not drop as fast as buyers would like, they've at least stopped climbing upward and are expected to drop for the foreseeable future.

Some folks in the market may ask themselves: With rates dropping slowly over many months, is it better to wait to buy until rates are significantly lower? We would advise not to let rates dictate your decision to that degree, for a number of reasons:

• There's never a guarantee that rates will fall. The expectation that rates will fall gradually over the next year and beyond is a consensus of analysts based on current economic data. Circumstances can always change. Rates could take years to drop significantly, or may not drop at all.
• The current forecasted cuts are incremental. The difference in monthly payment on a 30-year fixed-rate mortgage at the current market rate (around 6.4%) compared with at the consensus projected rate at the end of 2025 (around 5.9%) is only $111*. That's nothing to sneeze at, but in the grand scheme of homeownership costs, it's a drop in the bucket, and not worth putting life on hold - or missing out on a year’s worth of equity - for. 
• Housing prices are unlikely to go down - which means savings could end up a wash, or worse. The last time that housing prices decreased significantly was during the Great Recession of 2007-2012. Housing prices in Johnson County have risen steadily in recent years, with the median sale price up 1.3% year over year despite rates climbing in that period. As rates go lower, pricing growth is likely to accelerate, potentially eliminating any on-paper savings. That's before factoring in the opportunity cost of not building equity while waiting for rates to fall.
• Current rates are actually pretty good, historically speaking. Rates below 7% are hardly a historical norm. From 1973 to 2000, rates dipped below 7% just once. Although rates were below 5% from 2010 to 2021, that time span covered the Great Recession and the recovery from it, and the COVID pandemic. Very low interest rates can easily be a "careful what you wish for" phenomenon, as they're often the monetary policy response to recession (just as high rates are the response to inflation). It’s not a given that rates will drop to pre-COVID levels in the next decade, and waiting around for such an outcome just isn’t worth it. 
• There are ways to get creative with loan structure to ensure optimal value. Working with an experienced loan officer is an essential part of the home buying process - they can help you understand the various loan structure options available and build the most advantageous package for you. These options include rate buydowns, adjustable rates, and, eventually, refinancing. With these financial instruments, you may be able to get a better deal than the current market rate. 

If you find yourself discouraged or confused by interest rates, or just want to learn more about how they factor into the big-picture home buying decision, we'd be happy to sit down with you and help you get a handle on it. Our goal is to put you in the driver’s seat toward the home of your dreams.