Homebuyers received an unexpected gift around the holidays as mortgage rates dropped rapidly late last year.

“The direction we’re headed is down this year,” says Claudia Sahm, founder of Sahm Consulting and a former economist for the Federal Reserve. “But how far down … is a big question mark.”

Higher mortgage rates had effectively frozen the housing market last year. But they fell in mid-December after the Fed indicated that its campaign of raising interest rates to tame inflation was over—and the Fed could cut rates three times next year if inflation continues to moderate.

Mortgage rates are separate but directly influenced by the Fed’s short-term interest rates. So when the Fed reduces its rates, mortgage rates are likely to decrease.

“We expect a gradual reduction in mortgage rates, but it’s going to play out in fits and starts,” says Realtor.com® Chief Economist Danielle Hale. “We could see rates tick a little higher before they continue to fall.”

Mortgage rates have, in fact, climbed a bit recently.

They averaged 6.75% for 30-year fixed-rate loans on Friday, up from a low of 6.61% in late December, according to Mortgage News Daily. The rise is a result of new unemployment data released last week that shows the economy is stronger than the Fed would prefer as it continues to fight inflation.

Many investors had expected the Fed to begin slashing its rates as early as March, which would likely have resulted in mortgage rates falling. But the Fed might keep rates high for longer as it considers the strong jobs data along with how much inflation is coming down. The more the economy cools, the quicker the Fed could cut rates.

“We will see some bumpiness and mild volatility as we go through January and February, but mortgage rates will keep heading modestly lower,” says David Stevens, CEO of Mountain Lake Consulting, which services the mortgage industry. “We could see mortgage rates by year end at the bottom of the 6% range, and we could potentially go into the [5% range] if we see softening in the economy.”

How low will mortgage rates go?

While real estate experts are divided on just how much mortgage rates will fall, most expect they will stay in the 6% range. However, some believe they can dip into the high 5% by the end of 2024.

“There’s every reason to believe that we continue to move in the right direction unless there’s something that comes out of nowhere, which has been the story of the last couple of years,” says Sahm.

A rate in the 5% range could provide buyers struggling with the worst housing affordability in decades with substantial savings. Buyers who purchased a median-priced home with a 5.5% mortgage rate would pay about $216 less a month for their mortgage than those who locked in a 6.5% rate. And they would save roughly $442 a month compared with buyers with a 7.5% rate. (This assumes buyers put down 20% on a $420,000 home.)

However, the days of the 2% and 3% rates offered during the COVID-19 pandemic aren’t likely to return.

“I don’t think we’ll ever see them again at those levels,” says Stevens.

The Fed wouldn’t reduce its rates by enough to bring mortgage rates down to those lows unless the U.S. economy was in dire straits.

“If we ended up back there, we’d be in a very bad recession,” says Sahm.

How lower mortgage rates will affect the housing market

Lower mortgage rates are already having an impact on the housing market.

When rates went down at the end of last year, New Jersey–based mortgage lender Shmuel Shayowitz saw more first-time homebuyers get pre-approved for loans. Even more encouraging were the conversations he began having with homeowners about how they would consider selling and moving into new homes when rates went down into the 5% range.

“Because the thought is rates will be lower, more people are comfortable jumping back into the market,” says Shayowitz, president of Approved Funding in River Edge, NJ.

Two years ago, mortgage rates in the mid-6% would have scared off (or priced out) many would-be buyers. By now, though, buyers have had time to get used to them. They might even seem like a bargain compared with the roughly 8% rates seen in October.

However, reduced rates might be a double-edged sword as more would-be buyers enter the market. The nation is still struggling with an extreme housing shortage. Additional competition for a limited number of homes for sale could usher in the return of bidding wars and push home prices even higher.

“It will cause a noteworthy amount of pickup in the market,” says Jacob Channel, the senior economist at LendingTree, an online financial services marketplace.

Many homeowners who snagged ultralow rates during the pandemic will remain reluctant to move and give up those savings. And mortgage rates and prices will still remain high. This will make purchasing a home a significant financial challenge for many buyers.

“The housing market’s not going to go crazy,” says Channel. “It’s not going to be as active as it was or as frenzied as it was when rates were record lows in 2020 and 2021.”