What Homeowners and Homebuyers Need to Know About the Fed Rate Hike
If you’re in the market to buy a home, or you recently became a homeowner, you’ve probably noticed that mortgage interest rates are ticking up. And just this past March, the Federal Reserve increased the Federal Funds rate by one-quarter of a percentage point for the second time since December. Coincidence? Probably.
We’ll get more into what the Fed rate hike is all about below, but the burning question is: What impact does it have on mortgage rates? Most importantly, how will it affect home affordability and your monthly budget?
To help you make major mortgage decisions going forward—ones that have the potential to impact you for the next 30 years—we’ve broken down what the Fed rate hike really means for current and future mortgage borrowers, and the actions you should consider.
Before You Panic, Know What the Fed Rate Is
The federal funds rate is the interest rate at which banks and credit unions lend reserve balances (which are held at the Federal Reserve) to other institutions overnight. Put in simpler terms, it is a very short-term interest rate. Although it sets policy and a financial tone that affects everything from the stock market to consumer confidence, it doesn’t necessarily mean that mortgage rates react in exactly the same way. After all, they are typically 30 years in term, which is way longer than overnight.
Although there is technically no direct correlation between the Fed rate hike and mortgage interest fluctuations, the fact that it signals a recovering economy is relevant. At eight years post-recession and with a stronger job market, the country no longer needs a super-low Fed rate to promote economic growth. Not only that, rate increases are usually done in response to rising inflation. That’s what the Fed is doing, a quarter of a percentage at a time. This isn’t a big shakeup to lose sleep over; the Fed is merely reacting to modest growth and inflation.
To really get a handle on where mortgage rates are heading, you would need to look at what’s happening with the longer-dated 10-Year Treasury note. But don’t worry—you don’t need to have majored in finance to understand how this all affects you.
Just know that the rising mortgage interest rates likely have to do with today’s stronger economic outlook, and there are actions you can take in response, no matter the cause.
Your first move? Explore the numerous home loan options you have so you can make an informed decision.
If You’re Part of the “Home Shopping Network”
Rates are still low for homebuyers right now, but time is of the essence. So is knowing which type of mortgage is best for you:
Fixed rate mortgages: Even with recent highs, mortgage rates are still very low by historical standards. The average interest rate for a 30-year, conventional, fixed-rate mortgage was 4.17% in February, still well below the 5-6% levels before the housing crisis. Still, every percentage point increase brings up monthly payments. If you’ve found a home and plan to be in it for the long haul, it might be a good move to lock in today’s rate before it rises again. (SoFi’s rate lock is good for 45 days.)
Adjustable rate mortgages (ARM): SoFi’s 7/1 ARM is a unique product in that it offers a lower initial interest rate than what you’d get on a fixed product. This can help you afford more house, but it does come with some risk. After seven years—in month 85—the rate will adjust and will continue to adjust yearly based on LIBOR (“index”), a benchmark rate banks charge each other for short-term loans in the wholesale money markets in London, but is used by U.S. capital markets. A margin will be added to this index to determine the adjusted rate.
If you don’t expect to be in your home for more than seven years, a 7/1 ARM makes logical sense. But even if you do end up staying, the up-front savings might be worth the risk of fluctuating rates later on.
If You’re in the “Monthly Mortgage Club”
Homeowners should assess if they can improve their current loan as rates continue to rise based on the options available:
Fixed rate borrowers: If you’re currently in a fixed rate mortgage, the Fed rate hike does not affect you at all since you’re locked in for the life of the loan. And, if you locked into your mortgage post-crisis, you probably have a great rate already, so it’s unlikely today’s rates can compete. The verdict? You should probably stick with your current mortgage. If rates improve significantly in the future, you always have the option to refinance.
Adjustable rate borrowers: If you’re in an adjustable product that’s ending, or if your annual rate reset is approaching, now might be an ideal time to refinance. With interest rates forecasted to reach 4.6% by the end of 2017, locking into a fixed loan now can prevent higher monthly payments down the line.
Low equity borrowers: If your original loan was above an 80% LTV (loan-to-value) ratio, you might also benefit from a refinance in a rising rate environment. In other words, if your down payment was less than 20% of the purchase price, you started out with little equity in the home. With the rise in home values over the last few years and the payments you’ve already applied, however, you might find your equity has increased enough to remove the PMI (private mortgage insurance) you’re probably paying.
Say you purchased your home for $200,000 with a 10% down payment of $20,000. That makes the principal mortgage balance $180,000. Over the past few years, your home value has increased to $250,000, and because you’ve made some payments, you now owe $172,000 on your loan. That brings the equity in the home up to $78,000 (the $50,000 home value increase plus the $8,000 you’ve paid toward the principle), which means you now have 26% equity.
If you think you could benefit from a mortgage refinance, be sure to crunch the numbers to see how long it will take to recoup the closing costs and other fees that will be rolled into the new loan. As long as you plan to stay in the home for several years and can qualify for a favorable rate, it’s likely a good move. Remember, because you’re going through the home loan application process again, your credit, income, and debt load will all factor into whether you’ll qualify, and for what terms.
By the way, much of the above advice also applies if you’re still working on paying off your student loans. Furthermore, if you are carrying high-interest credit card balances, that’s one type of debt that is closely tied to the Fed rate hike, meaning you can expect card interest rates to go up, too. Consolidating all of your personal debt into one personal loan product can help remove the sting of even higher interest.
Whether it’s the Fed rate hike or some other economic or personal finance factors—like buying your first home—that inspire you to assess your current situation, exploring your borrowing and refinancing options periodically can help you stay in control and ahead of your finances.
Contact SoFi to lock in today’s mortgage rates before they change again.