The Federal Reserve's expected announcement of a rate increase on Wednesday has big implications for prospective home buyers and sellers, but experts have four words for anyone who's feeling that they need to act immediately: Don't do anything rash!
The Fed is widely expected to raise the federal funds rate by a quarter point, from a zero-0.25 percent range to 0.25-0.50 percent, for the first time in nearly a decade in an effort to keep the economy from overheating. When the Fed's rate goes up, so do interest rates of all kinds of other consumer loans, including mortgages.
Because mortgages are longer term than many other loans, even a small increase in interest rates can mean a buyer will pay many thousands of dollars more over the life of the loan. But moving quickly to try and lock in the lowest rate may not make sense, depending on your overall financial picture, experts say.
"Homeowners should not accelerate or decelerate their purchase decisions based on a market forecast," said Peter Lazaroff, wealth manager and director of investment research at Plancorp. "All markets, including interest rates, are forward looking. That means that debt prices have already built in expectations for slightly tighter monetary policy."
The Fed's rate and mortgage rates
While the Fed's impending rate decision already has sent mortgage interest rates inching higher from historic lows and a rate hike will send them higher, experts note that it won't happen at once and it won't happen quickly.
The federal funds rate is directly tied to short-term market rates — credit cards, for example — but long-term mortgage rates are not directly affected by the Fed. Nonetheless, Lazaroff said it is reasonable to expect higher mortgage rates over time.
Ahead of the Fed's meeting, the average 30-year fixed mortgage inched up to 3.95 percent last week, a slight increase from 3.93 percent and almost two-tenths of a point from its six-month low of 3.76 percent.
But Lazaroff said further increases are likely to be gradual, meaning that prospective buyers and sellers have some time before higher rates really begin to bite.
That doesn't mean that there is no need to start moving if you're serious about buying a home, said Melanie McShane, an independent real estate broker in Southern California.
Even a slight change in interest rate can make a big difference on your home loan, she said. For example, let's say you have a $300,000 loan with a 3.95 percent 30-year fixed mortgage. Your total interest payment would be $212,500. With a rate of 4.25 percent, you'd pay a total of $231,295 in interest. At less than half a percentage point increase, that's nearly a $20,000 difference.
"I've been in the industry for 11 years now and have seen the impact interest rate fluctuations have on homebuyers," she said. "As the interest rates move up, the total loan amount that the buyer qualifies for decreases. Typically a buyer has a fixed amount in mind of how much they are comfortable spending monthly. As the interest rate moves up, that fixed monthly payment buys less and less home."
And with mortgage rates still near historic lows, this remains a good time for potential homeowners to lock in a low, fixed interest rate, she said.
But timing a purchase depends on more than just mortgage rates, said Robert R. Johnson, president and CEO of The American College of Financial Services. As interest rates rise, the market is likely to become more competitive.
"There is often a hidden benefit to higher rates," Johnson said. "All else being equal, if interest rates are higher, home prices are generally lower because of supply and demand effects. If there is lower demand, sellers may be forced to sell homes at lower prices than might exist if rates were lower."
McShane, however, doesn't think the impact of waiting will be that substantial.
"I don't believe that there is going to be a benefit to waiting other than more selection," she said. "I do not believe that home prices will fall enough to be a significant factor in waiting to purchase a home."
Lock in a fixed rate
Most experts agree that new buyers should prefer a fixed mortgage. Because further increases seem likely over at least next year, an adjustable rate mortgage would almost certainly mean paying more interest.
"I believe that new homebuyers should look to lock in fixed rate mortgages sooner rather than later," said Johnson. "Rates have nowhere to go but up and homeowners should access cheaper money now."
The draw of adjustable rate mortgages (ARMs) is the initial rate is usually slightly lower than a fixed rate loan. But if interest rates increase over time, ARM increases will usually cancel out any savings.
For example, let's again say you're borrowing $200,000. If you have a 10/1 ARM at 3.95 percent (meaning it will stay at the initial interest rate for 10-years), with a maximum rate of 8 percent, you would potentially pay $180,000 in interest over the 30-year life of the loan. With a 30-year fixed mortgage at a higher rate of 4.25 percent, you'd only pay about $154,000 in interest over the life of the loan. There are a number of factors that can influence these numbers, such as the length of time you live in a house. (You can use this calculator to crunch the numbers yourself.)
As a potential homebuyer herself, McShane is looking to lock in a fixed rate sooner rather than later.
"Fixed rates right now are very attractive and I would certainly recommend that for anyone who does purchase," she said. "First time home buyers should understand that even with a slight increase in interest rates, now is still a great time to buy. But they should not purchase more than they can comfortably afford. We are not in the market cycle where rates are going to decrease so that they can refinance."