Curve

Federal Reserve raises rates as expected, but we could be in for a wild ride

Gina Pogol
The Mortgage Reports editor

Federal Reserve: No news is not necessarily good news

The Federal Reserve Bank’s Open Market Committee (FOMC) concluded its meeting today, and as expected the Fed raised its target short-term interest rate by .25 percent from 1.50 percent to 1.75 percent.

However, that information was already priced into current mortgage rates because investors and lenders had long been anticipating this. The Fed under former Chair Janet Yellen indicated that it expected to raise rates three times in 2018.

Verify your new rate (Dec 11th, 2018)

But will there be a fourth increase in 2018?

The Fed announcement provided no indication that there would be an extra rate raise this year. Chairman Jerome Powell said that the current policy of gradual and predictable rate increases has done its job well, and is likely to continue.

March 2018 mortgage rate forecast

He noted that if the current policy of raises proves too slow, they may speed it up in the future. And he did indicate that there will be three raises in 2019 instead of the two originally planned by former Chair Janet Yellen.

The only thing to fear is fear itself

Despite the Fed’s official position, there are causes for concern for mortgage borrowers. First, if investors believe that rates will rise, that affects bond prices because they will demand higher returns. The prophecy becomes self-fulfilling.

According to the Wall Street Journal, investors are pricing in a 31 percent chance that rates will rise four times this year, and an 8 percent chance of five increases, says research firm CME Group Data.

Fed members disagree wildly

The other reason we could be in for a roller coaster ride is that even Fed officials are not taking the same stand. The most “hawkish” members, the most likely to vote for more increases, believe that they should push rates (from today’s 1.75 percent) to nearly 5 percent by the year 2020.

Housing affordability crisis? Data says “no”

One wild card is the effect of the Trump tax cuts. Intended to stimulate the economy, they could end up causing it to overheat, fuel inflation, and actually diminish buying power.

On the other hand, the less extreme FOMC members believe that there should be only modest hikes, or even that they should hold today’s rate indefinitely. It really depends on inflationary pressures as they materialize, or fail to materialize, over the next few weeks.

Action steps for mortgage shoppers

There is little to suggest that rates are headed any way but up over the next few years. If you have a fixed-rate loan today, congratulations. You are set.

Your future is not so predictable if your rate is adjustable or if you have not yet bought a home. If the hawks win out, your mortgage payments will go up, and your home buying power will go down.

Home buyers not deterred by rising prices or mortgage rates

However, most believe that this process will be gradual. The Fed’s announcement reads:

“Recent data suggest that growth rates of household spending and business fixed investment have moderated from their strong fourth-quarter readings.”

Currently, the Fed expects inflation to remain just below 2 percent per year, and that should keep interest rate increases to a predictable and low level.

What about ARM mortgage rates?

If you have an adjustable rate loan (ARM), you’ll need to get out your loan documents and do some calculating. When will it reset if rates are 1 percent, 2 percent, or 3 percent higher than they are now? Your loan should have caps that limit how much your mortgage rate can increase at any one reset or over its life. Would that rate be affordable?

Alternatively, did you get that loan while planning to sell your home before rate resets became a possibility? How is that timeline holding up? If you planned to sell this year but are now looking at three more years, consider a 3/1 ARM refinance before rates go higher.

How ARM rates work: 3/1, 5/1, 7/1 and 10/1 mortgages

If you expect to be in your home indefinitely and have an ARM resetting soon, you have a couple of options. Accelerate your repayment so that there will be a lower balance to worry about when your rate rises, refinance to a new ARM now while rates are relatively affordable, refinance to a 15-year fixed loan (the rate should be about the same s the 5/1 ARM), or bite the bullet and refinance to a 30-year fixed loan while rates are still under 5 percent.

Home equity lines

When the Fed raises interest rates, the first and greatest effects are felt in short-term lending. That includes your credit card rates and variable home equity loan rates like you’d have with a HELOC. Many HELOCs come with convertibility features that allow you to lock in the rate of your current balance. Ask your lender if you have this feature.

Convertible HELOCs let you fix your interest rate

Rate increase: Should you buy a new home ASAP?

The recent rate increase was actually very small and had little effect on long-term financing like mortgages. Don’t jump the gun if you are not otherwise ready to buy a home because the financial fallout could be worse than a small addition to your monthly payment.

What do Fed rate hikes do to mortgage rates?

However, if you’re sitting on the fence, it might be a good time to get off and get pre-approved for a home loan. And shopping intelligently for your loan and choosing the right mortgage could easily offset a relatively insignificant increase in rates.

Verify your new rate (Dec 11th, 2018)