new paper Yale University professor Kelly Shaw argues that consumers are mistakenly waiting to take out mortgages and other long-term loans when the Fed is expected to cut interest rates.
Their confusion seems to be related to the mixing of short-term and long-term interest rates, which do not necessarily move in tandem.
In fact, short-term interest rate movements are usually already built into long-term interest rates, meaning there is no need to wait for a lower interest rate.
The savings from lower short-term interest rates should already be reflected in a long-term loan such as a 30-year fixed mortgage.
Regardless, home buyers and even professional forecasters tend to get this wrong, according to research.
Short-term vs. long-term interest rates
Consumers have long misunderstood the relationship between the Fed and mortgage rates.
Many people mistakenly believe that the Federal Reserve directly controls mortgage rates, so when the Fed announces a rate cut, potential home buyers expect mortgage rates to fall as well.
For example, the Federal Reserve is widely expected to cut the federal funds rate by 25 basis points (or possibly 50 basis points) at its September 18 meeting.
When this happens, we will see a lot of articles about “how mortgage rates will fall” and the like.
Some might also assume that the 30-year fixed return fell by the same amount, whether it was 0.25% or 0.50%.
So, if the 30-year fixed rate was 6.50% the day before the meeting, a hypothetical home buyer might think the going rate was 6.25% or even 6% the next day.
They will likely be disappointed if they talk to their loan officer or mortgage broker.
Mortgage rates are unlikely to change much. Worse, they may actually rise after the Fed announces a rate cut!
It all has to do with short-term and long-term interest rates, with the federal funds rate being a short-term rate, while the 30-year fixed rate is a long-term rate.
Although these factors may influence each other, there is no direct correlation. That’s why you won’t hear mortgage rate experts advising you to use the federal funds rate to track mortgage rates.
Alternatively, the 10-year bond yield is a good way to track mortgage rates, as they have a very strong correlation historically.
Simply put, they are both long-term rates and work very similarly because many home loans are paid off in a decade or so despite being offered over a full 30-year period.
Should You Wait for the Fed to Cut Interest Rates Before Refinancing (or Buying a Home)?
Which brings us to consumer behavior in relation to interest rate cuts and rate hikes. Before we talk about interest rate cuts, which are finally on the table, let’s talk about interest rate hikes.
When the Fed is expected to raise interest rates, people tend to rush out and lock in their loans before rates rise further.
The researchers, including Professor Xu, Richard Townsend, and Chen Wang, also see this as a “mistake.”
They point out that knowing “that the Fed plans to gradually raise short-term interest rates does not mean that long-term interest rates will gradually rise at the same time.”
Conversely, they say, “long-term interest rates jump immediately in response to such an announcement,” meaning there is no rush to hold rates steady before the Fed acts.
Now when we flip the script and think about interest rate cuts, the same logic applies. If you’ve been waiting to buy a home or refinance your mortgage because of an impending rate cut, that could be a mistake.
The Fed’s planned rate cuts are announced in advance and are known to market participants, so there won’t be a big surprise on the day of the announcement that will lead to a big improvement.
At least not on the interest rate cut announcement itself. That’s why mortgage rates defy logic the day the Fed makes its announcements.
Sometimes the Fed raises interest rates and mortgage rates fall, and sometimes the opposite happens.
Again, this is due to the disparity between short-term and long-term interest rates.
What about long-term monetary policy?
While I agree with the researchers on the point of short-term interest rates being cut and already being incorporated into longer-term interest rates like the 30-year mortgage, there is something else to consider.
The expected long-term monetary policy of the Federal Reserve. If the Fed has just started cutting short-term interest rates, there is a chance that long-term interest rates will continue to improve over time.
I know that researchers have already refuted this by talking about gradual rate increases, saying that people “fail to realize that the current long-term interest rate actually reflects expected future changes in short-term interest rates.”
Currently, there is a consensus that the Fed will cut interest rates by 200 basis points or more over the next year, Continuing Medical Education.
By the September 17, 2025 meeting, the federal funds rate could range between 3% and 3.25%, down from 5.25% to 5.50% currently.
Sure, you could argue that this is also part of long-term interest rates right now, but there is still some uncertainty.
If the Fed actually starts cutting rates, rather than just hinting at it, we could see longer-term interest rates fall even further.
Of course, this will depend on economic data and things like inflation and unemployment, which will only reveal themselves over time.
But if you look at the rate tightening cycle, which included 11 rate hikes by the Federal Reserve between early 2022 and mid-2023, you’ll see that mortgage rates have continued to deteriorate increasingly.
This rise was certainly also driven by fundamental economic data, namely out-of-control inflation.
However, the 30-year fixed rate of return has risen from about 3% in early 2022 to about 8% over that time period.
So those who decided to get out and lock in interest rates as soon as possible were rewarded. Even someone who opted for a 30-year fixed loan in March 2022 was able to get a rate of about 3% versus a rate of about 6% by June of that year.
In other words, what the Fed has already signaled may be baked into interest rates today, but what we haven’t yet discovered could push interest rates lower over time.
There is no guarantee, but it is worth considering.
Prior to creating this site, I worked as an account manager for a wholesale mortgage lender in Los Angeles. My experience working in the early 2000s inspired me to start writing about mortgages 18 years ago to help potential (and current) home buyers better navigate the home loan process. Follow me on Twitter for the latest news.
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