When the economy takes a turn for the worse and a recession hits, it inevitably affects the housing and mortgage markets. The impact can be significant, shifting mortgage rates, home prices, and lending standards in response.

Keep reading to learn what happens to mortgage rates in a recession to make a more informed financing decision when buying a home or refinancing.

What happens to mortgage rates during a recession?

In general, mortgage interest rates tend to decrease during recessions along with other benchmark interest rates.

There’s no better guide than historical data. For example, during the Great Recession from 2007-2009, the average 30-year fixed mortgage rate fell from around 6.5% to under 5%.

Rates also dropped during the early 1980s double-dip recession, the 1990-1991 downturn, and the 2001 dot-com bust recession.

Why? The answer is the Federal Reserve (Fed).

When the economy contracts, the Fed usually steps in to lower its federal fund rates. These, in turn, influence rates for auto loans, credit cards, mortgage loans, and other credit.

Economic woes also lead to a decline in mortgage demand, with unemployment spiking higher and dampening real estate transactions.

Consequently, lenders get much more competitive on rates when fewer borrowers seek financing during rougher recessions. After all, they want to put their capital to work.

The extent to which mortgage rates fall during recessions correlates with how sharply the economy contracts. The more severe the downturn, the further rates tend to drop.

For example, the Great Recession caused a steeper rate decrease compared to the relatively mild 2001 recession.

How the Fed influences mortgage rates

The Fed has a mandate to promote maximum employment and stable prices.

A large factor in what happens to mortgage rates during a recession dictates the Fed’s response, and that usually means lowering federal fund rates to encourage borrowing and spending.

In a process known as open market operations, the Fed buys and sells securities to manipulate short-term rates. That adds cash into the financial system, reducing interest rates through the nature of supply and demand.

The Fed also directly influences rates by adjusting the following:

  • Discount rate it charges banks
  • Federal fund rates banks charge each other
  • Reserve requirements regulating bank liquidity

Lower short-term rates influence long-term mortgage rates indirectly by:

  • Increasing bank reserves, allowing more lending
  • Boosting bond prices, lowering yields that mortgage rates follow
  • Signaling the Fed’s intent to keep rates low for an extended period

During the Great Recession, the Fed lowered rates to 0% while also utilizing quantitative easing. This involved large-scale buying of mortgage-backed securities to provide further stimulus.

A recession also brings tighter lending standards

Recessions cause declines in consumer spending and business investment (remember, less demand). Layoffs also often rise, leading to higher unemployment.

Because fewer people have stable income to qualify for home loans, lenders tend to tighten standards during downturns. Credit score and down payment requirements often increase.

Government-backed loans from the FHA, VA, and USDA loosen the reins to expand homeownership access. But conventional mortgages get more restrictive in lending policies.

Home prices also frequently decline during recessions as demand wanes. Lower prices combined with low rates keep homes affordable for buyers who do qualify despite tighter lending.

How mortgage rates rise again after recessions

As the economy emerges from recession, loan demand picks up again. With more borrowers competing over a limited credit supply, rates tend to rise.

Additionally, the Federal Reserve begins to tighten monetary policy again by:

  • Raising short-term interest rates
  • Selling assets on its balance sheet
  • Increasing bank reserve requirements

This reduces liquidity available for lending, causing rates to move higher across the board.

Eventually, the Fed’s actions, combined with an economic expansion, bring mortgage rates to pre-recession levels. However, the central bank acts gradually to avoid shocking the economy.

Beware of asset bubbles and price instability

When the Fed eases monetary policy during recessions, critics argue it can fuel excessive risk-taking and asset price bubbles.

Low rates may encourage investors to purchase riskier assets with higher expected returns. Lenders also loosen standards, allowing lower-quality borrowers to qualify.

If prices rise too much, as seen during the early 2000s housing bubble, it leads to eventual crashes and instability. Excessive easing intended to spur growth can backfire.

To quote The Big Short, a movie about the Great Recession: “No one can see a bubble. That's what makes it a bubble."

The Fed must walk a fine line between promoting recovery and maintaining stable prices during rate-easing cycles to avoid bubbles.

Strike while the iron is hot

The bottom line is mortgage rates tend to decrease in recessions, but not without caveats. While this can be an opportunity for some, it takes careful timing and preparation to take advantage of lower rates.

As of October 2023, mortgage interest rates are hovering around 7%—significantly higher than the sub-4% rates seen over the past few years.

This means borrowers need to be even more strategic with their finances if considering a home purchase or refinance.

Work closely with a mortgage professional to capitalize on any rate drops when the timing is right based on your unique home financing goals.