The years following the market crash in 2008 at times felt like a staging of “Waiting for Gadot.” Like the play’s title character, interest rate hikes never arrived, even though you expected them at any moment. For seven years, the Federal Reserve’s benchmark federal funds rate, the rate that banks charge to loan each other money overnight, remained at 0.25 percent.
Well, the “interest rate Gadot” has finally arrived on the scene. If you’ve been wondering how interest rate hikes affect borrowing money, then you’re not alone.
Since 2015, the Fed has been on a slow march of raising the benchmark interest rate, increasing it eight times, and it’s possible that additional rate hikes are on the horizon.
For good reason. The U.S. is no longer in a financial crisis, the economy is on relatively steady footing, and inflation is starting to emerge. Boosting interest rates can stem the rate of inflation.
Higher interest rates are also a welcome relief for savers who are now able to earn a stronger rate of return on their savings. But what does it mean for potential borrowers and homebuyers?
It’s Not Nearly as Bleak as It May Seem
Mortgage rates get a lot of attention when interest rates rise. But just because rates have inched upward in recent months, you may only notice a slight increase in your borrowing costs.
That’s because mortgage rates are more closely tied to long-term inflation expectations and economic outlook in the marketplace, not the central bank’s actions. But since interest rate increases are often imposed because of higher inflation expectations from the Federal Reserve, the benchmark rate and mortgage rates are often linked.
Today’s mortgage rates are still at historic lows — less than 5 percent. If the federal fund rate is boosted a quarter point, the amount you owe each month will be impacted, but not as much as you may think.
Let’s look at an example.
Say you’re a homebuyer who wants to purchase a $200,000 home. Assuming that the current interest rate is 4.94 percent on a 30-year fixed rate mortgage and you make a down payment of 20 percent, your monthly mortgage payment will be $1,312. If your interest goes up to 5.19 percent, you’ll only owe an additional $24 each month.
Ally Home Loans offers competitive interest rates that are compatible to a host of financial situations. Plug the current interest rate and your desired loan type into our Loan Payment Calculator to understand how much your mortgage payment could cost you each month.
But what if you’re considering an adjustable-rate mortgage (ARM), which has a fixed interest rate for a predetermined timeframe before resetting to correspond to the Fed’s benchmark rate? Since you can’t predict future interest rates, it’s difficult to determine what your mortgage costs will be in five, seven, or 10 years (common fixed-rate timeframes for ARMs). Rate caps protect borrowers by limiting how much interest rates can be increased over the life of your mortgage.
Not All Loans Are Created Equal
Interest rates on home equity loans and home equity lines of credit (HELOC) are tied to the prime rate, which is influenced by the federal funds rate. So rate hikes could affect these types of home loans.
Homebuyers often use home equity loans and HELOCs to pay for renovations or repairs, so higher interest rates mean you might have to pay more to redo your kitchen or install a new roof.
Home equity loans typically have a fixed interest rate. Rising rates could make home equity loans more attractive. To compare, the interest rate on most HELOCs are adjustable. Ultra-low introductory interest rates that accompanied HELOCs in recent years may no longer be as attractive to borrowers, since costs could jump drastically when the introductory period ends and the interest rate adjusts.
The Forecast for Existing Homeowners
The news is particularly good if you have an existing fixed-rate mortgage or home equity loan with a low rate. Since your interest rates are locked, your loan terms won’t be affected by any increases.
Borrowers with ARMs and HELOCs haven’t experienced significant jumps in their mortgage costs when their loans adjusted because interest rates have been at historic lows for a decade now. But if your ARM is still in its fixed rate time period and the Fed continues to raise interest rates, you could have a more expensive mortgage payment when that time period ends. HELOC owners could see increasing costs as well.
The Bottom Line
To be sure, if you’re shopping for a home loan, you’re probably looking at higher interest rates now than you might have been just a year ago. But that doesn’t mean your home buying dreams are out of reach. Mortgage rates remain relatively low and there could be federal programs to help you. Talking to a home loan expert at Ally Home costs nothing and can give you a true and straightforward picture of your home-buying options with no strings attached.
Higher interest rates are the natural result of a stronger, healthier economy. To manage them effectively, you’ll need to think carefully about which type of home loan and associated costs makes the most sense for you.