By Ann Saphir

(Reuters) – The interest rate for the most popular U.S. home loan plunged last week to its lowest level in 15 months, following the Federal Reserve’s signal of a potential policy rate cut in September and a slowdown in the job market, increasing financial market expectations for significant reductions in borrowing costs.

The average contract rate on a 30-year fixed-rate mortgage decreased by 27 basis points in the week ending August 2 to 6.55%, according to the Mortgage Bankers Association. This is the lowest rate since May 2023 and marks the sharpest decline in two years.

This drop offers potential homebuyers much-needed relief in an increasingly unaffordable housing market, which has seen rising home prices and borrowing costs.

The challenges of affordability were reflected in July’s housing sentiment index from Fannie Mae, a government-sponsored mortgage finance company. Only 17% of respondents believed it was a good time to buy a home, down from 19% in June. Additionally, 35% indicated they would rent their next residence—a record high since 2011.

Doug Duncan, Fannie Mae’s chief economist, noted, “It’s difficult to tell if this reflects simple buyer fatigue or a greater sense of disenchantment with the market, but this trend could have significant implications if it continues.”

Refinance Wave

The drop in interest rates also allows those who purchased homes at higher rates to refinance and reduce their payments. The MBA reported that the 30-year average rate peaked at 7.9% last October. Refinancing applications surged to their highest level in two years, increasing the refinance share of overall loan applications to 41.7%, the highest since the Fed’s first rate hike in March 2022.

However, purchase activity rose by less than 1%, hampered by low housing inventory that has driven prices up.

Currently, the Fed is keenly aware of labor market health and inflation reduction, maintaining its policy rate in the range of 5.25%-5.50% for over a year. Following the previous Fed meeting, the U.S. Labor Department’s jobs report revealed a rise in unemployment to 4.3% in July, with slowed hiring, raising recession fears.

This instability led to a drop in equities worldwide, although major U.S. stock indices showed recovery. Labor market data also triggered a rally in U.S. Treasuries, driving yields down and pulling down mortgage rates, benefiting millions of Americans seeking affordable housing.

Rate Cuts Coming

Even though the Fed kept rates steady during its July meeting, its post-meeting communication signaled a strong focus on labor market conditions alongside inflation goals. San Francisco Fed President Mary Daly stated that this focus has contributed to lower mortgage rates as investors anticipate future actions from the central bank.

Interest rate futures suggest that the Fed may cut its policy rate by a full percentage point by the end of the year, starting with a half-percentage-point reduction next month.

More than 4 million mortgages issued since 2022 have interest rates of 6.5% or higher, as reported by Intercontinental Exchange’s ICE Mortgage Monitor. However, over 60% of mortgages have rates below 4%, indicating that many homeowners would only consider refinancing if rates drop significantly more, or to encourage them to purchase a new home and list their current one for sale.