Don't Just Watch the Fed: The Real Key to Understanding Mortgage Rates

If you’re thinking about buying or refinancing a home, it’s completely understandable if your eyes are glued to the news coming out of the Federal Reserve. We’re trained to think that when the Fed cuts its target interest rate, all other rates will immediately follow suit.

So, when the Fed announces a cut and the 30-year mortgage rate barely budges, it can be frustrating and confusing. We saw this happen in 2024, and it highlights a common misunderstanding I discuss with my clients. The truth is, the Fed’s rate isn’t the main driver of mortgage rates.

As your financial planner, I want to give you a better place to look—one that offers a much clearer picture of where mortgage rates might be heading.

The Real Force Guiding Mortgage Rates

To make sense of this, let’s use an analogy. Think of the 30-year mortgage rate as a massive ocean liner. Now, think of the Federal Reserve’s short-term rate as the local wind. The wind can certainly make some waves and has an effect, but it isn’t powerful enough to steer the entire ship.

The real force guiding that ship is the deep, powerful ocean current. In the financial world, that current is the yield on the 10-year Treasury bond.

Mortgage rates are much more closely tied to this 10-year Treasury yield than to the Fed’s short-term rate. Why? Because the long-term nature of these bonds more closely matches the typical lifespan of a mortgage. When I’m assessing where long-term rates could be headed, I watch this "current" and the two main forces that move it:

• Inflation Expectations: If investors believe inflation will be higher in the future, they’ll demand a higher interest rate on long-term bonds to protect their returns.

• Economic Growth: When the economy is expected to grow strongly, stocks often look more attractive than bonds. To compete, bond yields may need to rise to attract investors.

By focusing on these factors, we get a much more reliable sense of direction than by just watching the "wind" from the Fed.

What About the Extra "Spread"?

There’s one more piece to the puzzle. You might notice that mortgage rates are always higher than the 10-year Treasury yield. That gap between them is called the mortgage "spread."

This spread exists because lenders and the investors who buy mortgages on the secondary market add a buffer to cover their:

• Business costs and profits

• Risk of a borrower defaulting on the loan

• Risk that you might sell your home or refinance early

Historically, this spread has been around 1 to 1.5 percentage points, but recently it has been closer to 2 percentage points. Because this spread can get wider or narrower, it’s another key reason why mortgage rates don’t move in lockstep with any other single indicator.

Making Your Decision with Confidence

So, what does this all mean for you?

It means that while a Fed rate cut is welcome news, it’s unlikely to cause a massive, immediate drop in mortgage rates. History shows that only a fraction of a Fed rate change—about 26%—actually passes through to 30-year mortgages.

My goal isn’t for you to become a bond market analyst. It’s to empower you with a more realistic picture of how rates are set. By understanding that the 10-year Treasury yield is the true guide, you can better manage your expectations. This allows you to focus on what really matters: balancing the search for the right home with a financing strategy that fits your long-term financial plan, all with a little less stress.