What Increasing Federal Interest Rates Anticipate For Homeowners
Over the past decade, you've probably heard it many times. Finally, the Federal Reserve raised the fed funds rate. This news may make you want to yawn, but it is important to remember that a rise in Fed funds rate could lead to significant changes in your monthly mortgage payment.
Before discussing what rising federal interest rates mean for homeowners, let us first talk about the Fed Funds Rate.
What Is The Fed Funds Rate?
Fed funds rate (or the Federal Reserve Board) is the interest rate that banks borrow from each other. This rate directly impacts the prime rate, Treasury Bonds, and Wall Street Journal Index. These are the three major indexes lenders use to lend money, such as mortgages and credit cards.
The rate that mortgage lenders offer customers like you is determined by using one of these indexes for a base rate and then adding a margin based on the risk associated with the loan. If the base rate rises, the interest rates lenders offer to you will also go up.
In response to the health of our economy, the Fed adjusts its fed funds rate. For example, the Fed can lower the severity of a recession or raise it to slow inflation.
Impact Of A Fixed-Rate Mortgage
You may think that a fixed-rate mortgage means you don't need to be concerned about the Fed raising their rate. You are correct. Fixed-rate loans have a higher interest rate than adjustable-rate mortgages (ARMs). This is because fixed-rate loans are guaranteed to remain the same interest rate no matter what the Fed funds rate rises.
If you are interested in refinancing your existing fixed-rate mortgage or buying a second house with a new fixed-rate mortgage, the fed funds rates will rise. This will affect the interest rate and cost of all loan types.
Impact Of Adjustable-Rate Loans On ARMs And HELOCs
The fed funds rate is indirectly linked to adjustable rates. For example, if you have an adjustable-rate home equity loan (HELOC) with a variable rate, then you will likely feel the Fed raising the rate. Let's discuss both these loan types.
Let's start with adjustable-rate mortgages or ARMs. As you may have seen, ARM loans come with an initial fixed-rate period. The interest rate can then be adjusted each year based on the index's changes. The numbers in ARMs indicate this: A 5/1 ARM has an initial fixed-rate period of five years and can be adjusted every year thereafter. A 7/1 ARM is a fixed-rate ARM that can be adjusted every year for a period of seven years.
Your rate will not change if the Fed raises rates during your fixed period. However, your rate will likely rise within the next year once you reach your adjustable period. You can also expect your rate to drop if the Fed lowers its rate. Depending on when you have your mortgage adjusted, it could take weeks or even months for your mortgage payments to reflect the changes.
HELOCs are a bit more immediate. HELOCs are usually adjustable rates. This means that they will also rise and fall according to Fed decisions unless you have made a fixed-rate advance. HELOCs will probably show the changes much quicker than ARMs, as they adjust faster.
Bottom Line
The Fed's decision will not affect your existing loan if you have a fixed-rate mortgage. However, if you have an ARM, your rate will increase with any Fed increase or fall with any Fed decrease. So if you want to switch to a fixed-rate loan, rates may take some time to move.
