Published on December 28, 2016
Anyone who pays attention to financial news has likely been seeing many headlines recently about the rate increase and coming rate increases from the Federal Reserve. Most of the news speaks in broad economic terms that may seem confusing or unrelated to the life of the average consumer. In fact, news and predictions on what the Fed is planning have wide-reaching implications for just about everyone, although they appear subtle. Homebuyers or owners especially could benefit from developing a greater understanding about the Fed and how it influences the U.S. markets.
"The Fed's actions affect more than just banks and businesses."
While the Fed Funds rate has more than one way to affect mortgage and other loan rates, its primary tool is the Fed Funds rate. You likely have already seen reports that the Fed decided on Dec. 14 to raise the Fed Funds rate by a quarter point – to a range of 0.5 to 0.75 percent, from a range of 0.25 to 0.5 percent.
What does that mean for mortgage loan rates? The Fed does not control loan rates. By increasing its funds rate, the Fed increases the price and the return for financial institutions that borrow from or lend to other institutions through the Fed. A Fed Funds rate increase flows over into the economy most often because financial institutions increase their base rate – called their "prime rate" – in tandem with the fed funds rate. If financial institutions increase their prime rate, the rates on their loans increase.
So, what does it mean for mortgage borrowers and home buyers when the Fed raises rates?
Since the Fed influences what financial institutions charge for their loans, the cost of a mortgage is likely to increase in the coming year. With the Dec. 14 rate increase, Fed officials are also signaling more rate increases in 2017. While nothing is written in stone when it comes the Fed policy, it's safe to say significant rate increases next year will mean significantly higher rates on mortgages.
When rates are up, home owners expect to pay more in interest for their mortgage. Higher rates then also depress the price buyers are willing to pay for a home and thereby decrease home prices.
There are also considerations for borrowers considering refinancing. While many borrowers have already refinanced, if you are one of those who haven't done it yet, it may be time to explore your options.