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Your Guide To The Federal Reserve & Mortgages

10/19/2018 Jerrica Kowcheck

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The Federal Reserve & You: Questions and Answers

Perhaps you read the headlines -- in September, the Federal Reserve raised its benchmark interest rate to 2.25%, the third bump in 2018. Raising rates have been part of “The Fed’s” strategy since 2015, after nearly seven years where rates were near zero.

But even after reading the headlines, you may wonder, “How does this affect me?” It’s a good question, and here are some answers.

What is the Federal Reserve?

The Federal Reserve System is the United States’ central bank. The system regulates banks, credit unions and other financial institutions, while setting monetary policy that helps maintain a stable U.S. economy. A seven-member “board of governors” is appointed by the president to oversee this work, and also set the benchmark interest rate.

What is a benchmark interest rate?

This is the rate that financial institutions, such as banks, use to determine interest rates for lending to each other. Banks and institutions lend to each other to maintain “mandated reserve levels,” or the minimum each institution needs to be solvent.

The benchmark interest rate is also called the federal funds rate, or base interest rate. When this rate increases, it becomes more expensive for banks to borrow from each other. “The federal rate changes affect the short-term borrowing rate,” says Sherman Clayton, vice president of margin management at PennyMac Loan Services, LLC.

Why does the Federal Reserve change interest rates?

The rate is used like a gas pedal. To accelerate the economy, rates were at zero percent for years, after the Great Recession, making money easy and efficient to borrow.

The brake is applied and rates are upped when the Federal Reserve becomes concerned about an “overheating” economy, where prices and wages are rising fast. When money becomes more expensive to borrow, it slows the amount being borrowed, lent and spent – but people save more.

The reserve considers economic forecasts that include inflation, unemployment, economic growth and other factors, before deciding to change the rate.

How does the Federal Reserve’s rate change affect my current mortgage?

If you already have a fixed-rate mortgage, your rate stays the same for the life of your loan, whether 15 years or 30.

If you’re shopping for a mortgage, rates offered go up and down due to many factors. They can be influenced by Federal Reserve policy, including the federal funds rate and buying and selling government bonds, which can be complicated to understand – but you can read more here.

The Fed’s rate increases don’t cause mortgage rates to climb immediately – but do have a broad impact on the economy, which eventually leads to a rise over time.

Does the Federal Interest Rate affect my HELOC, ARM or other variable-rate mortgage?

Where variable-rate loans are concerned, “there’s a direct correlation to the benchmarked rate,” Clayton says.

Most variable-rate mortgage rates are determined by individual financial institutions, in combination with their unique established prime rate. Variable mortgage rates change, due to fluctuations in the prime rate. “The rate changes trickle down to everyone else, increasing savings rates, but also increasing interest rates for car loans or credit cards,” Clayton says.

Many lenders take the Federal Rate, and add a few percentage points to create their Prime Rate. This rate is used to calculate interest rates for credit cards, auto loans, small business loans, and adjustable- or variable-rate mortgages.

Should I refinance?

As prices climb, your monthly payment may also rise. “If you’re planning on staying in your home and have variable rate mortgage, you might start looking at fixed-rate loans, knowing rates will probably continue to rise into 2019 and beyond that,” Sherman says.

But if you plan to move, rising rates may not affect you before you sell. If you have high interest-rate credit cards you can pay off more quickly with a debt consolidation loan, that’s another option.

Are rising mortgage interest rates good or bad?

Rising interest rates can make a house more expensive, on a monthly basis. For example, if the interest rate for a home mortgage is 4% and then rises to 4.25%, you’ll pay more.

Increasing rates can also make housing prices unaffordable. What you could afford at a 3% interest rate may become impossible at 6%. So homeowners hoping to sell may need to drop prices to accommodate a new market.

But, Sherman cautions: “If you’re in an area of low supply and high demand, rising interest rates might not impact home values as much. There’s still pent-up demand for housing, and more Millennials are entering the market,” a market he sees increasing this year and through 2019.

How high can home mortgage interest rates go?

Home mortgage interest rates are historically low, currently – around 5%. Mortgage interest rates hovered around 16% in 1981, with some reaching up to 18%, Sherman says. The national average cost of a house was $82,000.

So now might be a good time to buy, sell, refinance, or otherwise take advantage of rates, before they head upward. To learn more about your options, get started online now, or get in touch with a PennyMac Loan Officer to learn more.

The views, information, or opinions expressed in this blog do not necessarily represent those of PennyMac Loan Services, LLC.