News headlines about interest rate changes may conjure a range of emotions, from hope to anxiety to confusion. But how does it impact your mortgage rate — and is it a cause for panic?
The Federal Reserve (or the Fed for short) changes interest rates from time to time and current global economic changes and tensions can turn the tide. So, whether you’re a current homeowner or hoping to become one, the changes could affect you.
In short, the Fed adjusts its benchmark rate as a means of spurring economic growth (lowering it) or slowing it if inflation is increasing too quickly (raising it). So while a drop in the Fed’s rate could indicate a slower period in the economy, it’s actually meant to catalyze economic prosperity — making it cheaper to borrow money whether you’re investing in a business, shopping with a credit card, or taking out a mortgage on your home.
In other words, higher interest rates mean more expensive monthly payments (and vice-versa), and while the difference might not seem so drastic month-to-month, even an extra $20 a month can add up over time.
Are all types of mortgages impacted by changes in Federal interest rates?
While adjustable-rate mortgages (ARMs) move in tandem with the Fed fund rate, you may be surprised to learn that not all mortgages rates are directly affected by it. Thirty-year fixed-rate mortgages fluctuate based on long-term expectations of inflation and future interest rates — a ripple effect that begins with the current state of the economy and interest rates. So, a Fed dip or rise might not mean much for you unless you’re looking to refinance (see below for more on refinancing).
But if you’re in the market for a new home or planning to refinance your current mortgage, a dip in the Federal Reserve’s interest rate can be good news for you. Because the interest on a fixed-rate mortgage doesn’t change over the length of your loan, scoring a low rate now means you’ll hang on to the same low percentage until the end of your loan term.
You may also consider an adjustable-rate mortgage, which typically means you’ll pay a fixed rate of interest for the first several years (commonly three, five, seven, or 10 years) before your interest rate is subject to change each subsequent year based on the Fed’s benchmark rate at that time.
ARMs often offer lower interest rates for the initial loan period than fixed-rate mortgages — which can make them more attractive during periods of time when interest rates are high.
While you run the risk of higher interest rates (and higher monthly payments) should the federal fund rate rise after your fixed-rate term has ended, you may also get to enjoy the money-saving benefits of a lower interest rate — no refinancing required — should the Fed’s rates drop.
Home equity loans and HELOC
If you’re redoing your kitchen, paving your driveway, or taking on another major home project, you may take out a home equity loan or home equity line of credit (HELOC) to finance the venture.
Home equity loans and HELOCs allow you to borrow money against the equity of your home, or the difference between your home’s market value and the remainder of your loan balance.
Both of these loan types are affected by the prime rate, and like mortgages, a rate decrease can be beneficial for you.
Similar to a fixed-rate mortgage, home equity loans typically have a fixed interest rate — so the lower the benchmark rate is when you take out the loan, the better. Interest rates for HELOCs, on the other hand, are more similar to those on ARMs. The rate may vary over time depending on the movement of the prime rate.
Those looking to finance a big project could benefit from doing so while rates are lower because taking out a loan during a dip period could help save some extra cash on an expensive project.
What’s in store for homeowners?
If you already have an existing fixed-rate mortgage, an increase or decrease in the Fed rates probably won’t matter much to you. That is, unless you’re planning to refinance. If a mortgage refinance has been on your mind, taking advantage of a lower rate may help not only reduce your monthly payments, but save you a significant amount of money over the life of your loan.
Homeowners with ARMs (who are out of their fixed interest rate period) or HELOCs may benefit from a decrease in the Fed’s rate as their interest rate will likely also drop. But, it’s important to remember the Fed can always raise rates again, so you shouldn’t expect lower rates to remain that way forever.
Those who may be most affected by a decrease in the federal interest rate? People saving for a future home. That’s because saving, money market, and certificate of deposit (CD) rates are also based on the prime rate — and a lower rate could mean less interest accumulating in your accounts.
When the Federal Reserve lowers interest rates, it isn’t necessarily bad news. It can actually be a positive if you’re taking out a mortgage loan or refinancing your current one. After all, lower interest rates mean smaller monthly payments — and more money saved in the long run.
Ready for your dream home? Ally Bank offers a range of mortgage options with competitive rates, so you can make monthly payments that work for your home budget.