What the Fed's Interest Rate Hike Means for Home Buyers and Homeowners

The day has finally come. After months of speculation and anticipation, the Federal Reserve announced Dec. 16 a raise in short-term interest rates for the first time in almost 10 years. U.S. News & World Report said the Fed chose to make its move due to a strengthening domestic economy. Since the 2008 economic crash, the Fed has kept interest rates near zero to assist in market recovery, but the central bank believes the economy is strong enough to support rate hikes.

Interest rates will only increase to between 0.25 percent and 0.5 percent to close 2015, but many home buyers and homeowners fear it could have horrible repercussions on their mortgages. Fortunately, this is not necessarily the case.

Will Rising Interest Rates Cause Rising Mortgage Rates?

Unfortunately, the answer to whether rising interest rates affect mortgage rates is not so simple. Technically, the answer is yes. Edina Realty explained that a borrower loses buying power when interest rates increase, which could cause an increase in his down payments as well as what he pays per month.²

Interest rates, however, are far from the only factor that could cause a change in mortgage rates. According to Realtor.Com's Chief Economist Jonathan Smoke, mortgage rates fluctuate all the time independently of interest rates. He told U.S News & World Report that mortgages change so often and vary so widely between lenders that such a small interest hike won't impinge on someone who takes the time to do his research and shop around for the right lender. The current climate will still have the right products to offer someone who puts in the time. 

If the rise in interest rates does cause mortgage rates to rise, it will be by a very small amount. In NewsOk, Smoke forecasted a 0.5 percent increase in mortgage rates over the next year. 

U.S. News & World Report said many of those who already own a home are likely to have 30-year fixed-rate mortgages and don't have to worry about the spike. Those who do have adjustable rate mortgages don't have a reason to fear either. If you purchased your home within the past five to seven years, then your interest rate is likely still locked, so the rate increase won't affect you. If your rate is no longer locked, experts say your payment is still likely to remain reasonable. 

"The increase in the mortgage rates are going to be so tame and so controlled that (homeowners) will be able to adjust over time," Svenja Gudell, chief economist for Zillow, told U.S. News & World Report. 

A Look Toward the Future

As the economy grows stronger, experts predict the Fed will continue to raise interest rates. Scott Anderson, chief economist at San Francisco's Bank of the West, predicted to The New York Times that the economy will grow by about 2.4 percent next year, which will lead the Fed to raise interest rates three times in 2016.¹ The spikes will be gradual, and by the end of the year Anderson predicted interest rates will be between 1 and 1.25 percent higher than they are now. 

According to U.S. News & World Report, this might cause a surge in home purchases now to avoid even higher mortgage rates later on. People scrambling to buy before interest rates rise again could be good news for the economy. Steve Rick, chief economist for CUNA mutual group, told U.S. News and World report that it could lead to faster economic growth. 

Still, rates will be rising so slowly that buyers don't have all that much to worry about.

"Consumers are cautious but they still have the capacity to spend," Anderson explained to the Times.⁴ "Jobs and incomes are growing, debt levels are low and gas at about $2 a gallon should help. When people realize the sky isn't falling because the Fed is raising rates, they will go back to their usual spending habits and save the day." 

So What Should You Do?

Most likely, home buyers should do exactly what they have always been planning to do, which is buy a home when the time is right for them. David Reiss is a law professor at Brooklyn Law School who specializes in real estate. He told Time Magazine that buyers should not let the Fed's choices frighten them too much. Part of the reason is that the interest rates already incorporate a rise in mortgage rates because the mortgage market takes the Fed's hike into account. 

The second thing that all potential home buyers need to do is breathe. Do not worry. Even if mortgage rates rise, they will do so very slowly. Do not rush into buying a home you are not ready for in anticipation of a huge spike. NewsOk suggested meeting with a mortgage broker to make a plan.³ The broker will help you examine your current financial situation and determine how various changes to interest rates could influence your ability to qualify for a loan in the future. 

Still, it is possible that rising rates will cause you to have to settle for a smaller home or fewer amenities than you have been dreaming of. It may be wise to adjust your expectations in case the spike affects you more than you think. Focus on everything you can control, like your credit score, your debt-to-income ratio and the amount you've saved for a down payment, and make sure you place yourself in the best possible shape when applying for a loan.

Sources

¹ New York Times
² Edina Realty
³ NewsOK
⁴ New York Times