The years following the market crash in 2008 felt, at times, like a staging of “Waiting for Godot.” Like the play’s title character, interest rate hikes never arrived, even though you might have 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 Godot” finally arrived on the scene. Since 2015, the Fed had been on a slow march of raising the benchmark interest rate, increasing it eight times. In 2019, though, the rate has seen two drops: first in July and again in September, bringing it from 1.75% to 2.0%.
While the U.S. is no longer in a financial crisis, the Fed cited global growth outlook and trade policy tensions as reasoning for the pivot. But the decrease isn’t necessarily an indicator of a declining economy, and it’s possible rates could return to their path of growth within the year.
Wondering what a rate increase would mean for you? Higher interest rates are a welcome relief for savers who are now able to earn a stronger rate of return on their savings. But for potential borrowers and homebuyers, it’s a bit of a different story.
It’s not nearly as bleak as it may seem.
Mortgage rates get a lot of attention when interest rates fluctuate. But even though rates have been trending upward in recent years, you may have only noticed 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 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 owe an additional $24 each month.
Likewise, a decrease in the interest rate will likely not have a major impact in your monthly payments, though your savings may be more significant in the long run.
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 time frame 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 time frames 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.
What do rising rates mean for existing homeowners?
If you have an existing fixed-rate mortgage or home equity loan with a low rate, it might not make much difference. 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 raises 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
If you’re shopping for a home loan, you’ll want to keep an eye on the movement of interest rates. While rates have seen a recent decline, the overall trend is upward. 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.
Dig into your mortgage options with Ally Home Loans.