(NerdWallet) – The Federal Reserve raised a bedrock interest rate on Wednesday. As a result, mortgage interest rates probably will go up, and rates on home equity lines of credit certainly will.
The Fed raised its target for the federal funds rate by 0.25%, or one-quarter of a percentage point. Other interest rates are built atop the federal funds rate, most notably the prime rate often charged on corporate loans by large banks. It, too, will rise 0.25%.
Fed interest rates are moving higher as an inflation-fighting measure.
“It is our job to get inflation down to 2%,” Fed Chair Jerome Powell said at a news conference after policymakers met in January.
With inflation running significantly higher than the central bank’s target, the Fed is expected to raise the federal funds rate multiple times this year. The rate started the year near 0%, and traders in federal funds futures are betting that it will end the year above 1.5%, according to the futures market’s CME FedWatch Tool.
How the Fed rate increase affects home buyers
Mortgage rates are likely to rise because they tend to move in the same direction as the federal funds rate. With the anticipated increases, mortgage rates could trend upward all year.
If you have already signed a contract to buy a home and have locked an interest rate, you’re in good shape. The lender can’t raise your rate.
But if you’re shopping for a home or plan to this year, mortgage interest rates might be higher by the time you get a purchase offer accepted. You can’t lock an interest rate until you have a contract to buy a home.
If mortgage rates substantially rise before you find a house, you may end up shopping in a lower price range. That’s because higher interest rates weaken your buying power.
How much you can borrow for $1,500 a month (principal and interest)
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Don’t rush to buy just because mortgage rates are rising, warned Robert Heck, vice president of mortgage for online mortgage broker Morty. Rates, he said by email, shouldn’t be “the exclusive driving force around whether someone should buy a home right now.” Of course, rates play into the decision, but personal and financial factors are paramount.
How the Fed rate increase affects mortgage refinancers
With interest rates going up, fewer homeowners will have the opportunity to refinance into a lower interest rate to decrease their monthly payments.
But not everyone refinances to shrink their monthly payments. Many people choose cash-out refinances: They refinance for more than they owe and take the difference in cash. That cash can be spent on renovations, debt consolidation, tuition or other things.
Rising interest rates could decrease the loan amounts that cash-out refinancers can afford to get because higher interest rates bring higher monthly payments.
A home equity line of credit is an alternative to cash-out refinances, but HELOC rates will rise this year. The same is likely to happen to fixed-rate home equity loans.
How the Fed rate increase affects homeowners with HELOCs
The interest rate on a home equity line of credit, or HELOC, goes up whenever the Federal Reserve raises the federal funds rate, and by the same amount. So, when the Fed increases the federal funds rate by a quarter of a percentage point, the rate on a HELOC will follow within a billing cycle or two.
HELOC rates are indexed to the prime rate, which is indexed to the federal funds rate. On a $50,000 HELOC balance, a 0.25% increase in the interest rate approximately means a $10.42 increase in monthly interest.
Interest rates on cash-out refinance, HELOC and home equity loans tend to be lower than rates on credit cards and personal loans, said Rob Cook, vice president for marketing, digital and analytics for Discover Home Loans, by email. According to him, “That means that leveraging your home’s equity will continue to be a compelling option even as rates rise.”
How the Fed rate increase affects home sellers
If you’re selling your home, you are probably taking offers more seriously when they’re from buyers who have been preapproved for a mortgage. But to have confidence in a buyer’s ability to afford your home, make sure the preapproval is based on current interest rates.
Why? Buyers preapproved at yesterday’s lower rates may no longer qualify for the same loan amount at today’s higher rates. So if you accept an offer from a buyer who ultimately fails to qualify for a mortgage, you’ll lose valuable time.
If interest rates rise substantially, you may end up selling to someone in a higher income bracket than you initially marketed your home to.