How Rising Interest Rates Affect Mortgages
Today, the Federal Reserve, the nation’s Central Bank, raised interest rates a quarter of a percent. This is the third time since the Financial Crisis. It’s a sign the Central Bank believes the economy is growing slowly and steadily and can absorb the effect that comes with raising rates.
What does this actually mean?
When the Federal Reserve raises interest rates, it costs lending institutions and banks more to borrow money. They, in turn, pass this cost through to the consumer when they lend money. This impacts any credit product like an auto loan, credit card, or a mortgage. When it costs more for the bank, it costs more for you.
Will your mortgage payment go up?
There isn’t a 1:1 correlation. Mortgage rates don’t automatically go up just because the federal interest rates go up. Mortgage rates actually went down today after the Fed made the rate hike announcement. If you are a current home owner, your fixed monthly mortgage payment won’t suddenly change.
What should you do?
First thing is to take a deep breath. It is important to remember that interest rates are still at historically low levels.
What happens next for mortgages?
The good news is that a rising rate environment causes lenders to be more competitive. When rates go up, fewer people are refinancing so that part of the market goes away. Lenders have to get that much more aggressive to keep their loan volumes up.
You will see lenders introducing products designed to keep your monthly mortgage payments low.
Recently, we’ve seen an increase in 40 year mortgages. This spreads your monthly payments over an additional 10 years when compared to a traditional 30-year-fixed. This loan type is attractive for anyone who wants to keep their monthly payments low. You will, however, be paying more interest over the life of the loan.
1% down payment programs (Yes, 1%!) gets first time home buyers into a home quickly, even with higher rates. In this case, borrowers do not have as much initial equity in their home. That will come later as they pay down the mortgage and if the value of the home goes up.
Interest-only products — Monthly payments are only towards the interest on the loan not the principal. You aren’t paying down the principal on the loan, but you have the option to increase payments at any time. This requires discipline if you want to actually pay down the principal balance.
The Federal Reserve announced that it will likely raise rates two more times this year. If rates continue to rise, ARMs (Adjustable Rate Mortgages) will likely become more attractive. To keep up loan volume, lenders cut their fees, profit margins, and yield, and pass those savings to the potential customers/borrowers. ARM rates are moving up as well, but could be substantially lower when compared to a 30 year fixed mortgage moving forward.
ARMs at a lower rate can be more attractive than when compared to a higher rate of a fixed mortgage, particularly if you aren’t going to be in your home for 30 years. (If you plan to stay more than length of your introductory ARM rate (often 5 or 7 years), however, there is a risk that the rate 5-7 years from now may be higher).
As always, you should talk to a qualified mortgage professional. They can look at your individual situation and walk you through the possibilities. The bottom line: Right now, don’t let the interest rate hike push you into a buying a home sooner than you are ready. A home isn’t just about numbers and transactions. It’s also about finding a place that is best for your and your financial goals.