The Federal Reserve has played a key role in the roller coaster nature of the housing market since 2020. After a period of hiking and then holding rates that kept home sales muted, the Fed is set to return to rate cuts this month.

When that happens, what will happen to the housing market?

How will Fed cuts affect the housing market? 

Fed interest rate cuts in general will bring about lower [mortgage] rates, which is a definite boost to the housing market, but it won't happen overnight. — Greg McBride, CFA, chief financial analyst for Bankrate

The housing market could benefit from a Fed rate cut, which is all but certain to happen when policymakers meet on Sept. 17 and 18. 

“Fed interest rate cuts in general will bring about lower [mortgage] rates, which is a definite boost to the housing market,” says Greg McBride, CFA, chief financial analyst for Bankrate. “But it won’t happen overnight or as a knee-jerk reaction to the Fed’s initial interest rate cut.”

“Once interest rates begin to fall, I think there’s a boom — on the homebuying side, but also on the homebuilding side — through access to capital,” says Jim Tobin, CEO of the National Association of Home Builders.

While homebuyers would welcome news of lower rates, they could also face the same run-up in home prices brought on the last time the Fed cut rates, in 2020.

“Lower interest rates could stimulate both increased home supply and demand,” McBride says. “The best-case scenario is a gradual decline in rates that is beneficial to home builders, homebuyers and home sellers, rather than a sharp plunge in mortgage rates that leads to a surge in demand that supply can’t keep up with.”

While the Fed doesn’t directly set mortgage rates, it does control the federal funds rate, which broadly determines how much it costs to borrow money, including the cost of home loans.

Learn more: How are mortgage rates determined?

From March 2022 to July 2023, the Fed raised that rate a total of 11 times, and has since held it between 5.25 and 5.5 percent. This has had ripple effects in the housing market, including on home prices and sales.

Prior to the latest rate-hiking cycle, the housing market was booming thanks to low mortgage rates, as well as an appetite for moving house in the pandemic. During this uncertain time, the cost of a 30-year mortgage fell to 3 percent, when the Fed took its key rate down to zero.

That rush in demand escalated home prices. In June 2020, a 30-year fixed mortgage averaged 3.44 percent. That same month, the median existing-home sale price was $294,400. One year later, rates were still in the 3s, but the median home price had shot up to $362,800 — a 23 percent increase.

Since then, mortgage rates have gone up considerably. So have home prices, though to a lesser degree.

There’s also a noticeable link between the Fed’s first rate hike in March 2022 and declining home sales.

As rates rose that year and into 2023, the annual rate of existing-home sales dropped, from an average 5.33 million in the second quarter of 2022 to an average 3.88 million in the fourth quarter of 2023. When rates tracked back down in the first quarter of this year, the annual rate of home sales ticked up.

Looking at the past two years, existing-home sales are now 32 percent lower compared to 2022.

The Fed’s moves have also had some impact on housing inventory, which hasn’t kept up with demand due to years of underbuilding, rising material costs, a labor shortage and more recently, the lock-in effect.

When the Fed slashed rates in 2020, the surge in homebuyer demand collided with an avalanche of homeowners refinancing to lower rates, keeping them in their homes rather than putting those properties on the market. By 2022, the months’ supply of existing-home inventory had bottomed out at 1.6 months, according to the National Association of Realtors (NAR). Generally, inventory is considered balanced at six months.

The months’ supply measure has since increased alongside mortgage rates, to 4.1 months as of June, according to NAR.

Between home prices, sales and inventory, it’s clear a Fed rate cut could help the housing market by way of lower mortgage rates. It remains to be seen, however, if those lower rates push home prices further out of reach, as in 2020.

“If demand and supply get out of whack, this could lead to a further increase in home prices, offsetting the affordability boost from lower rates,” McBride says.