(NerdWallet) – The Federal Reserve raised a fundamental interest rate on Wednesday. As a result, mortgage interest rates will likely rise, and home equity line of credit rates will certainly rise.
The Fed raised its federal funds rate target by 0.25%, or a quarter of a percentage point. Other interest rates are built on top of the federal funds rate, including the prime rate often applied to business loans by major banks. It too will increase by 0.25%.
Fed interest rates are rising as an inflation-fighting measure.
“It is our duty to bring inflation down to 2%,” Fed Chairman Jerome Powell said at a press conference after policymakers met in January.
With inflation well above the central bank’s target, the Fed is expected to raise the fed funds rate several times this year. The rate started the year near 0%, and fed funds futures traders are betting it will end the year above 1.5%, according to the CME futures market tool FedWatch.
How the Fed’s rate hike affects home buyers
Mortgage rates are likely to rise because they tend to move in the same direction as the fed funds rate. With the expected increases, mortgage rates could trend higher all year.
If you’ve ever signed a contract to buy a house and locked in an interest rate, you’re in good shape. The lender cannot raise your rate.
But if you’re shopping for a home or planning until this year, mortgage interest rates could be higher by the time you get an accepted offer to purchase. You can’t lock in an interest rate until you sign a contract to buy a house.
If mortgage rates rise significantly before you find a home, you might end up shopping at a lower price range. Indeed, higher interest rates weaken your purchasing power.
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Don’t rush to buy just because mortgage rates are rising, warned Robert Heck, vice president of mortgages for online mortgage broker Morty. Rates, he said over email, shouldn’t be “the sole driving force in whether someone should buy a home right now.” Of course, rates play into the decision, but personal and financial factors are paramount.
How the Fed’s rate hike affects mortgage refinancers
With rising interest rates, fewer homeowners will have the ability to refinance at a lower interest rate to lower their monthly payments.
But not everyone refinances to reduce their monthly payments. Many people choose cash-out refinancing: they refinance more than they owe and take the difference in cash. This money can be spent on renovations, debt consolidation, tuition or other things.
Rising interest rates could reduce the loan amounts refinancers can afford, as higher interest rates mean higher monthly payments.
A home equity line of credit is an alternative to cash refinances, but HELOC rates will rise this year. The same is likely to happen for fixed rate home loans.
How the Fed’s rate hike affects homeowners with HELOCs
The interest rate on a home equity line of credit, or HELOC, increases each time the Federal Reserve raises the federal funds rate, and by the same amount. So when the Fed raises the fed funds rate by a quarter of a percentage point, the rate on a HELOC will follow within a billing cycle or two.
HELOC rates are pegged to the prime rate, which is pegged to the federal funds rate. On a HELOC balance of $50,000, a 0.25% increase in interest rate means about a $10.42 increase in monthly interest.
Interest rates on cash-out refinance, HELOC and home equity loans tend to be lower than rates on credit cards and personal loans, said Rob Cook, vice president of marketing, digital and analysis for Discover Home Loans, via email. “That means leveraging the equity in your home will continue to be a compelling option even as rates go up,” he said.
How the Fed’s rate hike affects door-to-door sellers
If you’re selling your home, you probably take offers more seriously when they come from buyers who have been pre-approved for a mortgage. But to be confident in a buyer’s ability to afford your home, make sure pre-approval is based on current interest rates.
Why? Buyers pre-approved at yesterday’s lower rates may no longer qualify for the same loan amount at today’s higher rates. So if you accept an offer from a buyer who ultimately fails to qualify for a mortgage, you’ll lose valuable time.
If interest rates rise significantly, you could end up selling to someone in a higher income bracket than you originally marketed your home to.