How Will the Interest Rate Hike Affect Mortgages?
If you’re ready to buy a home, you want mortgage interest rates to be as low as possible — the lower your interest rate, the smaller your monthly mortgage payment. The news, then, that the Federal Reserve plans to increase its benchmark interest rate two more times this year might make you fret that the interest rate you get on your own mortgage loan might be higher.
But according to Tendayi Kapfidze, LendingTree’s chief economist, house hunters shouldn’t worry about the Federal Reserve’s plans.
That’s because the Federal Reserve, no matter what it does for the rest of this year, isn’t manipulating mortgage interest rates. It instead tinkers with what is known as the federal funds rate, the rate at which banks, credit unions and other financial institutions lend reserve balances to other depository institutions.
The Fed’s increases, then, won’t automatically lead to a jump in the interest rate you’ll qualify for when taking out a mortgage loan.
How rising interest rates affect mortgages
That may sound complicated, but what’s important is that the federal funds rate has no relation to mortgage rates. So even if the Fed does increase this benchmark rate, as it is expected to do in September and December, this doesn’t necessarily mean that mortgage interest rates will rise, too, Kapfidze said.
“The Fed rate has almost nothing to do with mortgage interest rates,” Kapfidze said. “Mortgage interest rates could increase during the rest of the year. They could go sideways. But there is no consistent, direct relationship between the Fed rate and mortgage interest rates.”
A good example? Kapfidze points to the last big cycle of interest-rate hikes from the Fed, one that took place from 2004 through 2006. The Fed consistently increased the federal funds rate during this period. But at the same time, mortgage interest rates steadily fell, Kapfidze said.
What is a good predictor of mortgage interest rates is the performance of the 10-year Treasury note, Kapfidze said. When the Treasury note falls, mortgage interest rates tend to do the same. The same happens in reverse.
“It’s not accurate, then, to automatically expect mortgage interest rates to go up when the Fed hikes its rate,” Kapfidze said. “That’s just not the case.”
The impact higher interest rates have on buyers
While a hike in the Fed’s benchmark rate won’t have a direct impact on mortgage rates, this doesn’t mean that these rates won’t rise anyway.
As of Aug. 30, the average annual percentage rate (APR) on the 30-year fixed-rate mortgage was 4.52 percent while the average rate on a 15-year fixed-rate mortgage stood at 3.97 percent, according to the Freddie Mac Primary Mortgage Market Survey.
That’s an increase from a year earlier — on Aug. 31 of last year, the average rate on a 30-year fixed-rate mortgage was 3.82 percent, according to Freddie Mac data, while the average rate on a 15-year version was 3.12 percent.
Higher interest rates mean higher monthly mortgage payments, which is why home buyers prefer buying when rates are at their lowest.
Say you take out a 30-year, fixed-rate mortgage loan of $200,000 at a 4.60 percent APR. Your monthly payment, not counting taxes and insurance, would be about $1,025. If you took out that same loan with an APR of 4.25 percent, your monthly payment (again, not counting taxes or insurance) would be about $984, or about $41 less per month — that could save of around $500 a year. And depending on how long you keep your mortgage — how long before you sell your home or refinance to a new mortgage loan — that could add up to a significant amount of savings thanks to that lower interest rate.
As interest rates rise, the cost of buying a home becomes less affordable, Kapfidze said. Rising interest rates today can have an especially big impact on buyers because home prices are increasing, too.
The National Association of Realtors reported that the median price of an existing single-family home stood at $269,000 in the second quarter of the year. That is up 5.3 percent from the median price of $255,400 in the second quarter of 2017, and is also the highest the median single-family home price has ever been. The combination of rising interest rates and prices, then, is making homes less affordable.
It’s unclear, though, how many potential homeowners will be unable to find a home they can afford because of this mix, Kapfidze said.
“The higher interest rates do have a negative effect on affordability,” he said. “The question is, to what degree? Compared to a year ago, when rates were lower, housing affordability has weakened. But if you look at rates over the long run, they are still historically low. Housing affordability, then, is still at a decent level historically.”
The impact higher interest rates have on sellers
Sellers, too, will see an impact from rising mortgage interest rates. Buyers can afford more expensive homes when interest rates are lower because their monthly mortgage payments won’t be as high. When rates increase, some buyers might be priced out of homes that they might have been able to buy when rates for 30-year mortgages were under 4 percent.
Kapfidze said that sellers, then, might have to lower their asking prices to increase their pool of potential buyers and sell their homes.
“As rates go higher and higher, there will be a smaller pool of buyers who can afford a home at each price point,” Kapfidze said. “Sellers will have to react to that.”
No one can state with certainty whether mortgage interest rates will rise or fall, Kapfidze said. It is possible, though, to look at trends and to make predictions on what is most likely to happen based on those.
And the good news for buyers? According to Kapfidze, the average interest rate on 30-year fixed-rate mortgages probably won’t hit 5 percent in 2018.
Mortgage rates probably won’t rise or fall by more than 15 or 20 basis points throughout the rest of the year, Kapfidze added. Considering that the 30-year fixed-rate mortgage stood at 4.60 percent when he noted this in an early August interview, Kapfidze is saying, then, that the average 30-year rate likely won’t rise to more than 4.80 percent (an increase of 20 basis points) or fall to lower than 4.40 percent (a fall of 20 basis points) throughout the rest of the year.
At the end of last year and the beginning of 2018, mortgage interest rates did rise, Kapfidze said. That was largely a reaction of President Donald Trump signing the Tax Cuts and Jobs Act into law at the end of 2017, Kapfidze said. Since that shock to the economy, though, mortgage interest rates have remained mostly flat.
Kapfidze said that mortgage interest rates since May have largely been moving sideways, varying by no more than 20 basis points during this time.
“I would suspect, absent some kind of shock, that for the rest of the year they will stay in this area,” he said. “There is no big economic policy on the horizon that we expect to be a shock to the system the way the tax cuts were. For the rest of the year, I expect mortgage rates to keep muddling around where they are now, barring some unforeseen circumstance.”