The Federal Reserve raised the fed funds rate to a quarter percentage point, now between 0.75% to 1.00%. Forget the stock market, which has shrugged off Fed chair Janet Yellen’s announcement last Wednesday. What’s on everyone’s mind is how this latest development will affect consumer finance products, particularly mortgages. Will it make homebuying more expensive? Is a refinance out of the equation? Here’s what we know and what you can do.
What’s the Fuss, Essentially
The Fed decided to increase its targeted range for the fed funds rate as the economy is doing well if we were to quote Ms. Yellen. This rate hike marks the third time since the 2008 financial crisis, the second time within three months, and the first of this year’s series of hikes intimated by the Fed.
The fed funds rate is an important, if not the most important, benchmark rate used by banks in lending money to consumers such as mortgages, credit cards, and car loans. If it rises, the bank will have to pay more when borrowing from Federal Reserve banks and will thus raise its interest rate to pass this cost to consumers.
Essentially, the rate increase will affect mortgages as follows:
- Most affected: Adjustable-rate mortgages and home equity lines of credit. These home loans have short-term rates that are tied to the prime rate, whose benchmark rate is the fed funds rate.
- Partially affected: Long-term mortgage rates. Ten or 15-year rates are not tied to the federal funds rate. But the yield or return on the 10-year Treasury bond has increased since election and this is the benchmark rate for long-term mortgage rates.
Your Course of Action, Most Likely
What you can do in this environment of higher rates, which by the way are still low by the past decades’ standards, are these:
1. Shop for rates. Whether you are looking to buy or refinance, always shop for the best lowest rate possible. Go beyond the advertised rates and approach lenders directly online or at their branches.
2. Lock in rates. No one can predict when rates will drop to their pre-election state. Now may be the best time to lock in a rate before it could go even higher.
3. Set your expectation. Expect to pay more to get a mortgage for a home. With 30-year rates averaging 4.30%, you’d have to pay $989.74 for a home with a $200,000 price tag with no down payment and 0.5 points to be paid. Although it’s possible for home prices to go down so sellers can get rid of their inventory amidst higher rates. It may also be a good time to get a hybrid ARM for a purchase loan to start out with a lower rate.
4. Refinance? Homeowners with ARMs and HELOCs with variable rates have to brace for higher payments as their rates adjust. If your ARM is nearing its reset fixed-rate period, refinance out of it and into a fixed-rate mortgage. The same goes with opting for the security of a fixed-rate HELOC over your adjustable-rate one.
It’s not just the fed funds rate that gets to dictate the movement of mortgage rates. And even if it does, the benchmark rate will likely sit at 1.5% in the basement level.
