Earlier this month, Federal Reserve officials increased the federal funds rate by 0.25 percent, marking their first rate hike since 2018. You might be wondering why they would do this amid high inflation and rising gas prices.
Increasing interest rates is a common economic strategy used to combat high rates of inflation. When the US central bank (the Federal Reserve) raises its rates, it restricts the money supply to banks and lenders, and this increases costs for borrowers. This typically causes a decrease in consumer spending, especially on big-ticket items like houses and cars. That decrease in sales volume helps to turn the tide on inflation, bringing it back into a more manageable range.
Understanding how the Fed benchmark rate affects the money supply to banks, and ultimately inflation, is only part of the equation for homeowners, though. If you’re looking to buy or sell a home, you want to know how this rate hike, and more expected to come throughout the year, will impact you. Let’s check out what you can expect.
WHAT IS THE FEDERAL RESERVE?
The Federal Reserve System (the Fed) is the central banking structure of the US financial system. It’s made up of 12 regional Federal Reserve Banks, each serving its own geographic region. These regional banks have various functions, ranging from acting as depository institutions to lending for other banks to issuing currency for circulation.
The Fed was created in 1913 in response to the financial panic of 1907. Before this, the United States was the only major economy with no central bank.
Today, much of the interest in the Fed focuses on its Federal Open Market Committee (FOMC), which is the group responsible for the policy decisions attributed to the Fed. It’s also the committee responsible for the money supply of the US.
WHY DID THE FED INCREASE INTEREST RATES?
The FOMC monitors the vitals of our country’s economy and monetary systems. With inflation at a fever pitch of 7.9% as of February 2022, Fed Chairman Jerome Powell announced the intention of the group to use its tools and policy-setting ability to stabilize and correct this trend.
By increasing the federal funds rate, the committee hopes to slow the rate of inflation. This decision comes after almost two years of record-low rates from the Fed, put in place during the COVID-19 pandemic to prevent a recession and stimulate a faster economic recovery.
The FOMC also stated that this increase is the first of six projected rate hikes for this year.
HOW THE FED RATE INCREASE AFFECTS HOME BUYERS
The benchmark federal funds rate doesn’t directly set mortgage interest rates. The Fed rate does affect the amount of funds banks have to lend, though, as well as how much banks must pay to borrow money. So, in turn, a Fed rate hike almost always results in increased rates for buyers.
There is good news, though: If you have already locked your rate, you’re in good shape! As long as your closing date falls within the lock period, you will be guaranteed that rate for your closing. If you haven’t signed a sales contract or are waiting for your house to be built, you’ll want to check with your loan officer about extended rate lock options, which can help you lock in your interest rate for a longer period of time.
It can be worrying to think about rates increasing throughout the year as you search for a home. It’s helpful to keep in mind that interest rates aren’t the only aspect of the housing market that will impact your home buying journey.
Home prices will also fluctuate as demand adjusts, so while you may be quoted a higher interest rate for your loan, that could potentially be offset by a lower purchase price. The most important thing you can do is stay connected with your real estate agent and loan officer, so you can adjust your budget and home search as needed.
HOW A RATE INCREASE AFFECTS EXISTING HOMEOWNERS LOOKING TO REFINANCE
Higher mortgage interest rates will likely result in fewer homeowners realizing an opportunity to refinance into a lower rate and monthly payment. But many Americans were able to take advantage of record-low rates during the pandemic and will be able to continue to enjoy that low rate as they pay off their mortgages.
If you need to utilize the equity you’ve built up in your home, you can review your options for a cash-out refinance, which may still be a good option to achieve your personal financial goals, even if the rate is higher than your current loan.
HOW THE FED RATE HIKE AFFECTS SELLERS
We’re still in a seller’s market, like much of the pandemic. Sellers continue to be able to take advantage of steady increases in home valuations and sale prices.
While the traditional expectation from a Fed rate hike would be decreased demand for large purchases, some experts predict the high, pent-up demand for housing across the country will continue and isn’t likely to be dramatically affected this year.
Although how much you can sell your home for may not be highly impacted, you will want to pay close attention to your buyer’s pre-approval status. Work with your listing agent to ensure each potential buyer is being reviewed thoroughly and that any pre-approval letters they provide are recent.
As rates continue to rise, an outdated pre-approval letter could leave you in a situation where your buyer doesn’t qualify for the loan, which will set your sale back.
Both buyers and sellers hear about a Fed rate hike and may get concerned that it means they won’t be able to afford their next home or be able to sell their home as quickly. With this introduction to the Fed and our breakdown of the rate increase process, you’re now better prepared with what to expect from the potential impact on your real estate transactions.
Our team is always ready to review the best loan options for you, and to discuss any concerns you have about the mortgage process, particularly related to changing market conditions. Get in touch with an FHM loan officer today for a free consultation.