If you have been following the news over the last few weeks, you will have no doubt heard that the Federal Reserve has decided to raise interest rates. The Federal Reserve announced that it is increasing the federal funds rate. These rates were nearly slashed nearly to zero in 2008 to help the economy ride face the financial crisis that turned the housing sector on its head. The federal funds rate determines how much interest financial institutions charge one another to borrow money. This rate has a direct effect on the interest consumers pay on credit cards, or when they take out a loan. Conversely, it also affects the interests consumers make on savings accounts and certificates of deposit.
This rate increase marks the end to historically low mortgage rates. However the impending rise in rates are expected to happen incrementally and take a bit of time. It could be even longer until there is a significant increase in 30 year mortgage interest rates.
However, it is important to keep an eye on these short-term rate increases, because if they continue to climb and inflation rises, prospective homebuyers will see mortgage rates rise significantly.
While this is no reason to go in to panic mode, there are a few things you do want to keep in mind.
Even with rates going up only fractions of a percent, it is still important to consider the long-term effect on a multiyear loan, it could end up being quite costly in the end.
Take the following example – A $300,000 loan with an interest rate of 4% over 30 years has a monthly payment of about $1,400. When you increase that rate to 6%, you will see an increase of $400 per month on your payment, up to $1,800. Over the lifetime of the loan this adds more than $130,000. Combined with the rising prices of homes it can quickly make purchasing a home more difficult, especially for first-time buyers.
If you are considering buying a house or refinancing, it is vital that you evaluate your financial health. Preparation is key to making sure you are well positioned to enter the market. Having a firm grip of your housing budget can save you thousands of dollars in interest.
Does this mean you shouldn't buy now? Absolutely not! It just requires careful planning and astute management of your finances.
Let's put it into historical perspective. For the purpose of illustration, we will say that in three years, the 30 year loan rate will average around six percent. In the 1970's, the average was around nine percent. In the 80's in jumped up to 13 percent and even hit just shy of 19 percent in 1981. In the 90's it was around nine percent. The 2000's have been pretty kind with rates between four and five percent. So all things compared, a six percent interest rate is actually not terrible.
Here are the two most important things you can do to help you on the path to homeownership in these changing times.
First – Know your score. Your credit score is key to securing the lowest rate possible. Make sure that you are reducing any debt and are making timely payments on your other accounts. Pull up your credit report to ensure that it is correct and that your credit has not been compromised.
Save, save save! While 5% to 20% down may be the average down payment in the area, there are programs such as VA for veterans and FHA that require anywhere from 0 down for VA loans to as little as 3.5% down for an FHA. However, any amount you can provide above and beyond the minimums can help reduce rates even further.
For first time homebuyers, probably the biggest impact will be on how much house they can buy. These new prospective homeowners may need to reevaluate how much house they can afford. Speak with your Realtor or loan professional to help determine how these new rates may affect your borrowing power.
On the bright side, the higher rates should help ease lending criteria. The extra security these higher rates bring will help offset the risk, therefore increasing the pool of qualified borrowers. It is conducive for lenders to make more loans. Also remember, if rates are rising it is because the economy is improving.
If you already own a home, should you refinance? For the last six years, we typically refinanced about every two years. This will probably slow down considerably now. If you have a fixed rate loan look at your current rate to see if it refinancing makes sense for you. However, if you have a have an adjustable-rate mortgage and plan to stay in your home for some time, you would definitely want to consider refinancing into a fixed-rate loan. Of course, you'll need to calculate fees and closing costs to have a sense of your overall costs.
Reading the writing on the wall, one thing is for certain. Rates are not going down any time for the foreseeable future. If you are looking to buy, now is the time to act.