Ask A Mortgage Banker: What Is A Fed Rate Hike And How Does It Affect Mortgage Rates?

    Ask A Mortgage Banker: What Is A Fed Rate Hike And How Does It Affect Mortgage Rates?

    Ask A Mortgage Banker

    July 28 2022

    How Does Federal Reserve Rate Hike Affect Mortgag Interest Rates?

     

     What Is A Fed Rate Hike And How Does It Affect Mortgage Rates? Recently, we have been getting a ton of questions from clients, and non-clients alike regarding the Fed raising rates, what that means for mortgages (as well as other financial products), and general questions about the Fed as a whole. So with that in mind, we have put together a great quick overview to some of the most common questions that we get about the Fed and mortgage rates, as well as what we are seeing currently in the real estate market and what we expect to see moving forward.

     

    What is the Fed anyway?

    The Federal Reserve (also known as the Fed) is the country’s central bank. It helps to regulate the U.S. economy by setting monetary policy, which means it decides how much money is available for lending and how high interest rates should go. When banks get more cash from their customers’ deposits than they need for current operations, they can lend that surplus money out to other banks that need cash plus a little extra profit on top. The federal funds rate is the rate banks charge each other for overnight loans of this kind; it’s also known as “the fed prime.”

     

    The Federal Reserve’s Federal Open Market Committee (FOMC) meets eight times a year.

    The Federal Reserve’s Federal Open Market Committee (FOMC) meets eight times a year to discuss the state of the economy and decide whether or not to raise or lower interest rates. The federal funds rate is the interest rate that banks charge each other for overnight loans. It’s also the basis for other interest rates throughout the economy. The Fed uses this rate to set borrowing costs for all kinds of loans, from mortgages to student loans and credit cards. The FOMC sets its target for the federal funds rate at its eight-to-twelve meetings each year, but it doesn’t make an announcement at every meeting. The first press release announcing a change comes at a regularly scheduled conference following that meeting’s close (the next one is September 20-21)


    At those meetings, the FOMC announces the federal funds rate, which is the rate banks are charged for overnight loans.

    The FOMC has raised rates 4 times this year already, mainly to combat inflation. In March of 2022 the FOMC increased it’s target range from 0.25% to 0.5%. In May, we saw another increase, this time of 0.5%, bring the target rate up to 1.0%. June saw another 0.75% increase from 1.0% to 1.75%, and yesterday’s vote to increase another 0.75% brings the benchmark interest rate to 2.5%. Wall Street forecasts predict an additional 1.5% increase between September’s meeting and the rest of the year, bringing the total projected increase for 2022 to 3.0%.


    That rate has a ripple effect, rippling up to short-term interest rates and out to long-term interest rates, including adjustable-rate mortgages and home equity lines of credit.

    The fed prime rate has a ripple effect on other interest rates. This is because it’s used as a benchmark for many other interest rates, including:

      • Short-term interest rates. Short-term loans have maturities of less than one year and include things like savings accounts and money market deposit accounts. These are called short-term because they don’t get paid back for more than one year, which means you can only collect the money once per year when the loan matures.
      • Long-term interest rates. Longer term loans have maturities of more than one year and include things like fixed-rate mortgages and adjustable-rate mortgages (ARMs).


    Most credit cards and other kinds of loans are tied to the prime rate plus an additional percentage.

    A base rate is the rate at which a bank lends to its most creditworthy customers. The prime rate is used as the base for several different types of loans and lines of credit, including credit cards and other forms of revolving debt. It’s also used as the baseline for adjustable-rate mortgages and home equity lines of credit.

    The prime rate is used as a benchmark for all types of consumer loans. Commercial banks add a margin to the prime rate when calculating consumer interest rates on products such as home equity lines of credit (HELOCs), mortgages, student loans, and personal loans. The rates on these products take into account the borrower’s creditworthiness.

    For instance, if the prime rate is 2.50% and the bank adds a margin of 2.50% to a HELOC, then the interest rate for that loan is 5% (2.50% plus 2.50%).


    When the Fed raises or decreases the federal funds rate, your credit card interest rate can be affected, as well as your variable-rate mortgage or auto loan.

    If the Federal Reserve increases its target range for the federal funds rate, your credit card interest rate could rise as well. This means that if you have a credit card with an introductory APR of 0% or intro balance transfer APRs, your interest rate will most likely increase when those promotional periods end.

    If you have a variable-rate mortgage or auto loan and there’s no fixed interest rate associated with it, your monthly payments may go up as well. That’s because these loans are tied to prime rates set by banks and other lenders, which are influenced by changes in the federal funds rate.


    When the Fed raises its federal funds target rate, that doesn’t necessarily mean you’ll immediately see higher APRs on your credit card or auto loan balance.

    The Federal Reserve does not actually set the prime rate. Instead, it sets a target for the federal funds rate (the rate at which banks borrow and lend to each other). That is then used by banks to determine what they charge their customers for borrowing money, but it’s not directly comparable to the prime rate. The prime rate is what commercial banks charge their best customers—typically large corporations or wealthy individuals—for loans of longer duration than overnight.

     

    Longer term loans are affected less quickly by increases in interest rates than shorter term loans.

    This is because the longer-term loan has a larger amount of time to adjust to its new interest rate, which takes more time than a short-term loan. For example, let’s say the prime rate increases from 4.50% to 5.25%, your monthly payment per $10,000 of debt would increase by about $12.50 per month (per $10,000 of debt)

     

    What we are currently seeing with mortgages and what impact the rate hike will have:

    Most people currently likely have an interest rate between 2.5 and 3.5 percent on their first mortgage from the period of interest rate lows. Now people are trying to get second mortgages and it’s taking 30-60 days to get them out.  Currently on the variable rates you can go up to 80-90% on loan to value but the interest rate is going to be somewhere between 7% – 9.5%.

    The good news is that the payment is going to be spaced out over about 30 years, versus something like an installment loan, which is another type of a second mortgage. With an installment loan, the term is going to be a fixed term over 15 years, so you might get a lower rate but you are going to have a higher payment because you are paying it back over 15 years. It is also closed-end, so you can’t draw on it like a home equity line of credit. A HELOC acts like a credit card, you as you pay it down you can draw on it again. 

    What we have seen happening very frequently as of late is everyone is taking money out on their second mortgages, even at the higher current rates, because what’s going to happen in about a year or two when interest rates go back down, everyones blended rate – if you have a 3.5% first mortgage and an 8.5% second mortgage, depending on how much you have on that second mortgage, the blended rate is going to be somewhere around 4.5%. So, interest rates will trigger have a re-fi boom when interest rates get back down to about 4.5% and everyone is looking to consolidate their first and second mortgages. We’re currently also seeing a lot of people looking to obtain/utilize their home equity lines of credit (HELOC) in order to get money out of their homes. We are talking to clients daily about taking some money out of their current property/properties and waiting for the market to settle while still being able to have money for their next down payment, when they decide the timing is rite between their personal needs and the market, and are ready to buy the next property in their portfolio.

    If you or someone you know has any questions about the Fed rate hikes and their impact on mortgages, is looking to evaluate their mortgage options and see which programs and products they best qualify for, or simply have general mortgage questions, we’re always happy to answer any questions our clients, or potential new clients, may have.

    So if you’re in the market for a mortgage, or simply want to see what your mortgage options are based on your specific situation in the current market, schedule a complimentary 30 minute mortgage consultation with Sean! Click here to schedule

     

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