The Federal Reserve has decided to increase its interest rates, a move that is bound to impact the housing market. This will affect mortgage rates as well as buyers and sellers.
It's important to understand what an increase in interest rates means for you if you're buying or selling a home.
Why the Federal Reserve raises interest rates
The Federal Reserve works to encourage a strong economy and stable prices by setting the nation's monetary policy. One of its main tools for achieving these goals is raising or lowering the federal funds rate — the rate at which all commercial banks lend money to each other overnight.
When the economy is strong and inflation rises, the FED may raise rates to cool things down. That's because higher interest rates make it more expensive for people and businesses to borrow money. This can slow spending and help keep inflation in check.
The federal funds rate also affects other interest rates, including the 30-year fixed mortgage rate. So when the FED raises rates, you can also expect your mortgage payments to go up.
Historical factors
Recently, the FED has just started to raise rates from historically low levels after keeping them steady for several years to help the economy recover.
The FED increased the federal funds rate three times in 2017 and once more in 2018. This was the first time in ten years they had increased rates. The other time this happened was 2006, just before the housing market crash of 2008.
The reason the FED seems poised to raise interest rates is to keep inflation under control as our economy continues to strengthen. Currently, inflation is at around 9.1% which is the highest it has been since 1981. Now the FED looks to increase it by 1% due to a strong economy.
In December 2015, the Federal Reserve increased interest rates. The federal funds rate was expanded by 0.25%, from a range of 0.0-0.25% to a range of 0.25-0.50%.
The average 30-year fixed mortgage rate at that time was around 4%. However, rates had been rising for several months before the FED's decision, and they continued to increase afterward. By February 2016, the average 30-year fixed mortgage rate had reached its highest point in nearly three years: 4.5%.
After that, rates began to fall again and have remained relatively low. The average 30-year fixed mortgage rate is now around 4%.
The federal funds rate isn't the only factor that affects mortgage rates. They’re also influenced by the yield on 10-year Treasury bonds, which tend to move in the same direction as mortgage interest rates.
When bond yields rise, so do mortgage rates. That's because when investors feel confident about the economy, they're more likely to put their money into stocks and other investments that offer higher returns. This can cause bond prices to fall and yields to rise.
What impacts mortgage rates?
Central bank decisions are just one of the many factors that can affect mortgage rates. Here are some others:
The FED
As we've just discussed, the Federal Reserve's monetary policy decisions can impact mortgage rates. Homebuyers and refinancers should pay close attention to FED rate announcements.
The discount rate and FED funds rate can affect mortgage rates. FED announcements are closely watched by the markets and can cause rates to move higher or lower.
Treasury bonds
Mortgage rates are influenced by the yield on the 10-year Treasury note. Yields and mortgage rates move in opposite directions: when yields go up, mortgage rates tend to fall, and when yields go down, mortgage rates tend to rise.
Inflation
Real estate is a long-term investment, and inflation can greatly impact how much your home is worth when you sell it. That's why mortgage rates are often higher when inflation is rising.
Condition of the economy
Mortgage rates are affected by the overall condition of the economy. When the economy is strong and growing, mortgage rates tend to rise. That's because a strong economy means inflation is likely to increase.
On the other hand, home prices usually fall when the economy is weak or in a recession, and mortgage rates tend to drop. That's because a weak economy means inflation is likely to go down, which makes lines of credit cheaper.
Yourself
Last but not least, the most important factor in getting a good mortgage rate is you. Lenders will look at your:
Credit score
Borrowing costs are lower for people with good credit scores because they're considered lower risk.
Debt-to-income ratio
This looks at how much of your income goes towards debt payments, including your mortgage. For a lower monthly payment, you could get a loan with a higher DTI, but you may have to sign up for private mortgage insurance (PMI).
Down payment
The larger your down payment, the lower your home loan borrowing costs. That's because you're considered to be a lower risk when you have more skin in the game.
Employment history
Lenders like a steady employment history because it indicates that you're less likely to default on your loan.
Income
Incomes affect home loan costs in two ways. First, the higher your income, the easier it’ll be to get approved for a loan. Second, incomes affect DTI ratios.
All these factors and many more are considered when lenders set mortgage rates. So if you're looking to buy a home or refinance your mortgage, keep a close eye on the mortgage interest rates forecast.
If you're unsure what kind of mortgage is right for you, talk to a lender. They can help you compare fixed-rate mortgages and adjustable-rate mortgages to find the best fit for your needs.
What should a homebuyer do?
Although a FED rate increase affects mortgage rates, homebuyers shouldn't panic. Instead, they should:
Research interest rates and compare lenders
Interest rate increase or not, it's always important to compare rates and lenders before you choose a home loan. So if you're contemplating buying a home, now’s still a good time to do your research and compare lenders.
Get pre-approved for a mortgage
Getting pre-approved for a mortgage is an awesome idea if you're not sure how much you can afford to spend on a home. This way, you'll immediately know how much you can borrow and how much you’ll owe in monthly payments.
Lock in a rate
If you're worried about rates increasing, you can always lock in a rate. A good number of lenders will allow you to lock in a rate for 30, 60, or 90 days. Naturally, this means you won't be able to take advantage of further rate decreases. But this will offer you peace of mind knowing that your rate is locked in.
Understand how an increase will affect a monthly payment
An increase of 25 basis points on a $250,000 loan will add about $30 to the monthly payment. Hence, buyers should consider how an increase will affect their monthly budget before deciding.
Be smart about the amount borrowed
With a higher monthly payment, buyers may be tempted to borrow less. But keep in mind that a lower mortgage rate could save you thousands of dollars in interest over the life of the loan. So it's imperative to strike a balance between how much you can afford and how much you should borrow.
What should a seller do?
If you're considering selling your home, the FED rate increases shouldn't stop you. Now may be a good time to put your home on the market. Here's why:
Understand that homes are still in demand
Even though interest rates are rising, people still need somewhere to live. So if you're thinking about selling your home, there's a good chance you'll find a buyer.
Remember it's still a seller's market
In most parts of the country, it's still a seller's market. This means that there are more buyers than sellers. So if you do put your home on the market, you're likely to get multiple offers and be able to choose the best one.
Know that urgency increases in summer months
People are generally more serious about buying a home in the summer months. If you do put your home on the market now, you may be able to sell it faster than you would at other times of the year.
Keep on learning
Now that you know how a FED rate increase can affect mortgage rates and the housing market, you can make a more informed opinion about buying or selling a home.
For more information on this topic, consult a lender or real estate professional. They can help you understand the short- and long-term effects of a FED rate increase on the housing market. They can also offer more specific advice on what you should do if you're thinking about buying or selling a home.