How Far Will Interest Rates Drop in 2025 and 2026?

Interest rates can punish or reward us.

Which is the case for you depends on whether you’re in debt or earning interest.

The market interest rates are strongly influenced by the decisions of the Federal Open Market Committee (FOMC). The “Fed” kept interest rates near zero from early 2020 to early 2022.

Finally, in March 2022, they realized inflation wasn’t “transitory” and decided they had to do something drastic about it. They embarked on…

The Fastest Tightening in Decades

Facing the highest inflation in four decades, from March 2022 to August 2023 the Fed tightened its monetary policy such that the Federal Funds rate soared from 0.08% to 5.33%, the fastest tightening in several decades.

If you were borrowing money, things became painfully expensive, as:

• Interest on credit card balances shot up
• Auto loan rates increased sharply
• Mortgage rates nearly tripled

If you were a saver, on the other hand, you finally started seeing some opportunities for higher interest income, including:

• Online banks (but not the big bricks-and-mortar ones) offered 5%+ interest on checking accounts
• Certificate of Deposit (CD) rates jumped to over 6%
• Short-term bonds and money market funds offered far higher yields than they had in years

Then inflation started falling back from the stratosphere, getting close to the Fed’s 2% target rate. That’s when…

The Long-Awaited Rate Cuts Finally Arrived

In September 2024, the Fed finally started cutting rates.

The first cut was an aggressive 50 basis points (one basis point is equal to one-hundredth of a percentage point). The next cut, in October, was a more common one — 25 basis points.

Unsurprisingly, this had the reverse impact than that of the tightening we’d just experienced.

Borrowing became (a little) less expensive, but interest payments on checking, savings, and money market accounts started decreasing too.

These changes have widespread impacts, including:

• Bond prices rise as interest rates fall.
• The appetite for investment risk — when you can get high interest on low-risk assets, why risk your money in stocks unless they provide a much higher return?
• Real estate becomes somewhat more affordable so demand ticks up, but as new mortgages become less expensive, more homeowners sitting on a 3% mortgage interest are willing to sell so pent-up supply is released.

If you were waiting for rates to come down (or fearing they would), this begs the question…

Where Will Interest Rates Go in the Coming Years?

One of my favorite quotes, often misattributed to Yogi Berra says, “It’s hard to make accurate predictions, especially about the future.” — Nils Bohr, Physics Nobel Laureate

In a similar vein, the ancient Jewish sage Rabbi Yochanan said, “From the day the Temple was destroyed, prophecy has been taken from the prophets and given to fools and babies.”

I haven’t been a baby in many decades and hope that I’m not such a fool as to be included in the second category, so I avoid making prophecies about anything.

However, I can still see what multiple expert sources project and try to figure out the range of possible developments.

I doubt any of these experts can reliably predict the future (they too are neither fools nor babies), but if we compare many predictions, the truth may well be somewhere within the range of those predictions, and the uncertainty can be sensed from how widely the predictions vary.

Expert Projections of Interest Rates in the Next Few Years

With interest rates determined by the Fed, we should first see what they project. According to the St. Louis Fed, interest rates in the coming years are expected to be:

• 2025: 3.4%
• 2026: 2.9%
• 2027: 2.9% (according to Federal Reserve Bank members and presidents, the median projection for rates after 2026 is 2.8% with a range of 2.4% to 4.9%)

Next, Morningstar’s research forecasts interest rates:

• 2025: drop from 4.75% to 3%
• 2026: drop from 3% to 2%
• 2027 (and later): 2.3%

Morningstar also mentions rates implied by futures markets:

• 2025: 3.25%
• 2026: 2.75%

Averaging the above (using mid-points for Morningstar’s ranges), we get:

• 2025: 3.5% ±0.33%
• 2026: 2.7% ±0.2%
• 2027: 2.6% ±0.42% (from Fed and Morningstar numbers)

One big caveat (related to the above statements about predicting the future) is that a-posteriori research shows that the futures market predictions don’t do so well:

“The three easing cycles [looked at were]… 1989–1991, 2000–2003, and 2007–2009. At one point during each of those cycles, the market underestimated the amount of Fed rate cuts by roughly 2.50%.”

How Do the Pros Think About Interest Rate Projections and How Do They Advise Clients?

I asked several financial pros about how they think of interest rate and what they advise their clients to do about them.

Lamar Watson, Founder and Financial Planner, Dream Financial Planning says, “For interest rate projections the first place I look is the futures market to see the interest rate yield curve. I also like to get a sense of the major investment banks and fixed-income money managers are forecasting. Since buying a home is important for several of my clients, I also have a few mortgage industry contacts I listen to for mortgage rate forecasts. Interest forecasts are often wrong. If we’re investing in fixed income, we always want to ladder maturities to minimize risk and to know what we’re investing for. Funds for short-term goals (less than three years) should be in cash, short-term treasuries or CDs, and/or high-yield savings accounts to minimize duration risk. If we’re concerned about rates regarding an auto loan or mortgage, I suggest ensuring you have a fully funded emergency fund first. Base the decision on your personal needs vs. interest rate forecast. For a house, I recommend that clients buy when they’re ready because you may later be able to refinance at a lower rate.”

Jason Gilbert, Founder and Managing Partner of RGA Investment Advisors gives his take, “Recognizing that projections can be uncertain, I emphasize the importance of maintaining flexibility in investment strategies while keeping a long-term, multi-generational perspective. For clients, this means conducting regular portfolio reviews and adjustments to align with evolving economic conditions and policy changes. At the core of my practice is a focus on holistic wealth management, which includes not only investment strategy but also tax efficiency, estate planning, and intergenerational wealth transfer. By staying nimble, we ensure that the family’s financial objectives—whether they involve preserving wealth for heirs, optimizing tax strategies, or adjusting to shifting fiscal policies—are met with resilience and foresight. We keep an eye on the bigger picture, ensuring that clients are well-positioned for their legacy goals, but we remain agile enough to make tactical adjustments when circumstances change. This balance between stability and adaptability is key to navigating today’s complex financial landscape while building a foundation that stands the test of time.”

Vishal Kumar, Partner at Twin Peaks Wealth Advisors expands, “As a financial advisor working with tech professionals in the Bay Area, I get asked about interest rate projections all the time. With the Federal Reserve doing its best tightrope walk between inflation control and economic growth, everyone wants to know: ‘Where are rates heading?’

“I keep a close eye on forecasts from a variety of sources—Federal Reserve statements, economic think tanks, and market trends. But let’s be real – no one, not even the Fed, has a crystal ball. Projections are influenced by countless variables, from global supply chain shocks to domestic employment reports. Right now, consensus points to rates stabilizing after the recent series of hikes, but there’s also chatter about a mild recession prompting cuts in the next couple of years. While it’s tempting to pin your strategy on these projections, I often remind my clients that projections are like weather forecasts: useful, but not foolproof. 

“As for prepositioning for likely scenarios, tech professionals often face unique financial considerations—equity-heavy portfolios, concentration in employer stock, and significant exposure to interest-rate-sensitive investments. For this group, the strategy often boils down to balance and flexibility. 

“Regarding debt management, if you have stock options or deferred compensation that will vest in the next few years, now might be the time to reevaluate your borrowing strategy. If rates stay high, variable-rate loans could become a pain point. Locking in fixed rates might make sense, but only after considering your liquidity needs and cash flow. 

“Many of my clients have portfolios that skew heavily toward growth stocks, which tend to take a hit in rising-rate environments. To balance this, we might look at high-quality bonds or dividend-paying stocks that can provide stability and income. But remember, there’s no one-size-fits-all approach. 

“Rate hikes often impact the cost of living indirectly—higher mortgage payments and pricier credit. Maintaining a robust emergency fund isn’t just boring financial advice; it’s peace of mind when life (or the market) takes a sudden left turn. Let’s face it—interest rate forecasts are wrong as often as they’re right. The question is how to prepare for that uncertainty. Here are a few ways…

“Don’t overreact to headlines: the financial world loves drama. Remember when ‘transitory inflation’ was the phrase of the moment? Markets are emotional, but your financial plan shouldn’t be. Stick to long-term goals. 

“Stress-test your plan: what happens if rates spike higher or drop faster than expected? Running scenarios can highlight vulnerabilities in your portfolio or plan. It’s not about predicting the future—it’s about staying nimble enough to adapt. 

“Use the tools you have: tech professionals often have access to deferred compensation plans, employee stock purchase programs, and mega backdoor Roths. These tools can provide tax-efficient ways to hedge against market volatility or leverage opportunities.

“Think globally: rates in the US don’t operate in a vacuum. International opportunities, like emerging markets or foreign bonds, might provide an unexpected hedge. 

“Finally, a word of humor and perspective – at the end of the day, financial planning isn’t about guessing where the Fed is headed—it’s about managing what’s within your control. I often tell clients: ‘If I had a perfect read on interest rates, I wouldn’t be managing your portfolio—I’d be managing my private island.’ But seriously, whether rates go up, down, or sideways, the goal is to build a plan that’s resilient and aligned with what matters to you. Interest rates are just one variable in a much bigger picture. Let’s stay focused on the picture. This approach reflects the nuance, humor, and practical insights my clients appreciate. It’s not about predicting the future—it’s about being prepared for whatever comes next.”

The Bottom Line: What Should We Take Away from All This?

First and foremost, the only way to know definitively the interest rates in 2025, 2026, and 2027 is to wait and see.

Of course, by then it’s too late to prepare proactively.

Second, averaging expert projections can give us what will likely be somewhat less inaccurate predictions, all of which expect rates to continue dropping to around 3.5% in 2025, 2.7% in 2026, and 2.6% in later years.

However, those numbers have uncertainties, so let’s state things in ranges:

• 2025: 3.2% to 3.8%
• 2026: 2.5% to 2.9%
• Later years: 2.2% to 3.0%

Given all that, here are my thoughts:

1. It’s never a good idea to carry a balance on credit cards or other high-interest loans, however, the pain of such a situation should become somewhat lower over the next few years.
2. Living on a fixed income from, e.g., CDs, checking accounts, savings accounts, short-term bonds, money market funds, etc. is no picnic unless you have a huge nest egg; this will likely become even more challenging in the coming years.
3. Ideally, approaching (and/or in) retirement we should invest some of our funds in growth assets to outpace inflation while using less-risky assets (e.g., bonds, rental income, etc.) to provide enough diversification to avoid a portfolio meltdown, especially early in retirement (to mitigate the so-called “sequence of returns risk”).
4. Keeping several years’ worth of expenses in cash and bonds when approaching (and/or in) retirement will cost you some growth but help you reduce the risk of having to sell stocks during a bear market. It’ll also help you sleep better when, not if, the market craters.
5. The larger your nest egg relative to your retirement spending, the more short-term risk you can afford to take, which means you can allocate a larger fraction of your portfolio to stocks because you won’t need to sell as large a fraction of your assets if you don’t hold enough cash and bonds to let your portfolio recover. Paradoxically, this means that the very wealthy can live in luxury while their portfolios effortlessly grow larger even as they spend lavishly, far beyond their needs.
6. Finally, borrowing from the above pros (and related to several of the above points), make sure your plan is resilient and agile enough to survive all the curve balls the market will throw your way over a decades-long retirement.

Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.