What will rising interest rates mean to you if you are considering purchasing a home or doing a cash-out refinance loan?
Fed funds rate. Mortgage-backed securities. Ten-year treasury. Thirty-year treasury. Federal reserve board. Mortgage interest rates. These are all commonly used terms, but what do they mean to us as potential borrowers?
In the near future, we are all going to have to ask ourselves: Do we want 3 percent mortgage interest rates with a sluggish recessionary economy — or 6 percent rates with a booming vibrant economy?
Mortgage rates bottomed out during the depths of the coronavirus pandemic as the Federal Reserve Board moved to keep the economy afloat by using a process called quantitative easing. Think of the lemonade stand that your children set up… but you were the only buyers? But now as the Fed returns to pre-pandemic policy, interest rates are rising, and likely will continue to rise. How quickly they rise and how high they will rise depends upon a multitude of economic factors.
Let’s take a look at what is driving interest rates higher. The answers are complex, but I like to start with the old adage: “What goes up must come down,” and vice-versa!
The Federal Reserve Board does not set mortgage interest rates — but their decisions definitely influence mortgage rates. The Federal Reserve sets borrowing costs for shorter-term loans in the U.S. by moving the fed funds rate. The fed funds rate is the rate at which commercial banks borrow and lend to each other overnight. This rate, during almost the entire time of the pandemic, was set at 0.25 percent — a historic low. On March 16, that rate was moved up 0.25 percent, sitting at 0.50 percent. The Fed Committee further indicated continuing increases at its remaining six meetings this year. They are attempting to combat spiraling inflation without severely slowing the economy. A delicate balance!
Movement, either up or down, of the fed funds rate influences corresponding movement in Treasury Bonds. Mortgage interest rates, those that we are most concerned with, are most closely tied to movement of the 10-Year Treasury Bond. Why would what is typically a 30-year fixed mortgage loan be tied to a 10-year bond? The answer is because most mortgage loans tend to pay off over a 10-year timeframe as homeowners refinance, move, or otherwise pay off their loan.
So what is the prediction for the 10-Year Treasury Bond? Treasury bond yields go up if the Federal Reserve raises the fed funds rate, or merely if they indicate a desire to increase the rate.
Where does that leave us, the consumer considering buying a home or thinking about using their new found equity to do a cash-out refinance loan? The good news is that the predicted rate increases in both the fed funds rate and the corresponding 10-Year Treasury rate are forecast to be small. Thus the increase in the mortgage interest rate will also, hopefully, be small.
Although the historic interest rate lows brought on by the worldwide pandemic are now in our rearview mirror, I think it’s a good time to look forward. A philosopher once said: “Looking back gives you regrets. Looking ahead gives you opportunity.”
Lets’ look at some actual numbers to see what makes sense, today. If you are considering a home purchase that would give you a mortgage balance of $400,000, then a 2 percent rate increase would make a $500 per month difference in your payment. If this increase doesn’t stop you from qualifying, then you may need to consider a few things. Do you think it is reasonable to assume the home you are buying may increase in value by $6,000 a year over the next five years? And, what are the other benefits of homeownership?
What if you were considering a cash-out refinance, but now you are reconsidering because rates have moved up? Once again, I think it’s prudent to run the numbers and see if they still make sense. If you were going to pull out cash to pay off higher rate debt, like credit cards, or if you wanted to unburden yourselves from that student loan debt, or if you just wanted to build a nice nest egg in your bank account — do the numbers still make sense to you? Can you save yourselves $500, $1,000, $1,500 a month in payments by taking out that loan? If it does, you may still want to act now.
To see an opportunity we must keep an open mind. Alexander Graham Bell said: “When one door closes, another opens, but we often look so long and regretfully upon the closed door that we do not see the one which has opened for us.”
Rick Piette is the regional sales manager for All Western Mortgage.