Will Fed Cuts Lower Mortgage Rates?

Sep 19, 2025

Interest rate cuts have sparked hope that mortgage rates will finally fall and reignite the housing market. However, lowering home borrowing costs involves complex market factors.

Key Takeaways

  • Interest rate cuts by the Fed may not necessarily lead to lower mortgage rates. 

  • Home prices near record highs, combined with stubbornly high mortgage rates, are slowing activity in the U.S. housing market.

  • For home sales start having sustainable growth, mortgage rates would need to fall about 100 basis points. 

The U.S. housing market is currently experiencing its slowest activity in more than four decades, leaving investors—as well as buyers and sellers—hoping for a turning point as the Federal Reserve lowers interest rates. Although conventional wisdom suggests that mortgage rates will follow suit, the path to recovery may be more complex.

 

“We don't think that the Fed cutting rates as the market expects is sufficient cause for the 30-year fixed mortgage rate to come down,” says Jay Bacow, Co-Head of Securitized Product Research at Morgan Stanley. 

 

Bacow points out that mortgage rates are actually 25 basis points higher than they were before the Fed cut rates by a full percentage point between September and December 2024. He attributes this counterintuitive trend to two key factors:

 

  1. Treasury bond correlation: Mortgage rates are more closely tied to the yields of 5-year and 10-year Treasury bonds, which have continued to rise despite Fed cuts, than they are to the Fed funds rate.

  2. Market expectations: Financial markets are forward-looking. If rate cuts are anticipated, they’re already priced in—meaning bond yields may not react unless there’s a surprise.

     

Following the Fed’s Sept. 17 reduction of the benchmark interest rate by 25 basis points to a range of 4% to 4.25%, Morgan Stanley Research anticipates five additional 25-basis-point cuts in the meetings of October, December, January, April and July, bringing the terminal rate to a range of 2.75% to 3%. 

 

Twin Challenges for Buyers: Affordability and Supply

Home sales in the U.S. have been little changed as prices are near record levels and mortgage rates remain stubbornly high, a combination that makes home ownership increasingly unaffordable. 

 

“To brutally oversimplify the affordability equation, it has three primary components: home prices, mortgage rates and income,” says James Egan, who is also Co-Head of Securitized Product Research at Morgan Stanley. “Lower mortgage rates would help improve affordability.”

 

The average rate on the existing universe of 30-year mortgages is 4.1%, while new loans are priced closer to 6.5%. This gap of more than 200 basis point gap has persisted for three years—an unprecedented stretch in recent history.

 

Higher rates also discourage homeowners from listing their properties. Those locked into lower rates are reluctant to sell and face higher borrowing costs on their next purchase. This limited supply keeps prices elevated, further straining affordability.

 

What Could Move the Needle

If Fed rate cuts won’t necessarily lower mortgage rates, reducing the mortgage risk premium might help. For example, if mortgage originators can sell loans to investors at tighter spreads, mortgage rates could decline.

 

Based on data from previous periods when affordability improved, Morgan Stanley Research estimates that mortgage rates would need to fall about 100 basis points—to around 5.5%—to trigger sustainable growth in home sales, assuming the U.S. avoids a recession.

 

“In this scenario, we forecast 5% growth in existing home sales in 2026, with the potential for faster growth in 2027,” Egan says.