The Federal Funds Interest Rate Changed. Now What?
The Federal Funds Interest Rate Changed. Now What? Lead Gen!
What happened?
On September 18, the Federal Reserve moved to lower the cost of borrowing money by a half percentage point. This was a much larger drop than anticipated (most experts were predicting a quarter of a percentage point).
Fed Chairman Jerome Powell said the Fed was “encouraged” by strong overall progress on inflation and economic output. These comments lead many to speculate that more cuts may come in Q4 of 2024, totaling perhaps as much as another half point by the end of the year. Even with this rosy outlook, these potential future cuts won’t be as large as this initial one.
What does it mean?
The cost of money is changing. As we wrote in our Mortgages 101 explainer:
Federal funds rates are set by the Federal Open Market Committee, which establishes a kind of baseline for individual banks to later determine their own interest rates to be. The federal funds rate is the rate that banks pay each other to borrow money overnight. Essentially, the government requires banks to have a certain amount of money within their reserves and when banks lend funds to borrowers, they then have to re-balance their reserves to meet these requirements. So, if the federal funds rate increases, chances are that banks will increase the interest rates that they charge borrowers to pass along the cost.
In the case of lowering the federal funds interest rate, as the Fed just did, the process works to first lower the cost of banks lending money to each other, and then to eventually lower to the overall cost of borrowing money for average consumers. These two rates end up mirroring each other.
You can see this in the following chart, which shows the correlation between the federal funds rate and the average mortgage interest rate:
Source: KW Research, Freddie Mac, and the Federal Reserve
While we can expect mortgage interest rates to trend downward after the Fed’s decision, they won’t do so overnight. Experts estimate the lag time for any significant change could be anywhere between eighteen months and two years. But, it should still come. Slow and steady is the name of the game.
So, this rate change helps affordability?
Yes and no.
Affordability really comes down to the cost of a monthly mortgage payment. The lower a mortgage payment is, the better it is for most consumers.
Mortgage payments are the result of a few things (again, see Mortgages 101), but these two are largely at play currently:
1. Interest rates
2. Sale price
So, interest rates are going down, but it may take more than that to help ease affordability concerns. Housing prices vary market to market but have largely risen due to lack of supply.
There is currently a national shortage of available single-family starter homes in the United States in the early 2000s. Part of this is a result of the Great Recession, an economic downturn that began in late 2007 and lasted until 2009. In the decade that followed the Great Recession, construction rates on new homes dropped by nearly half.
Source: National Association of Home Builders
This drop in construction combined with a lack of building affordable housing meant that a decade later, in the 2020s, there’s a much greater demand for housing than there is supply. As many as 2.5 million homes are considered “missing” from the 2020s inventory because they simply were not built.
So, until there is more supply to ease demand, prices won’t decrease too much. That means affordability challenges, particularly for first-time home buyers who are unable to leverage equity toward property purchases.
So, what do I do?
- Reach out to your clients.
If you have had difficulty following these changes and their impact, imagine how non-agents feel. Your sphere certainly could use your help understanding them. “Everyone has questions right now,” Ruben Gonzales, KW’s Chief Economist says.
Whether you’re engaging with people one-on-one, writing a newsletter, or recording a video for your social media, providing context for these national headlines will establish you as the local economist of choice.
- Advise those on the sidelines to strengthen their finances.
Though the overall interest rates and prices of homes are outside of an individual buyer’s control, they have more control over how much they can invest. Generally speaking, the more a buyer puts down on a property at the beginning of a mortgage, the better interest rates they get. Plus, the overall amount of the mortgage loan will be lower.
They can also look to their credit scores and income-to-debt ratios. For help on discussing these topics, brush-up on the qualifying framework LPMAMA.
To learn more about these rate changes and even more ways you can engage your database, check out KW’s September Market Snapshot.