Increases in the fed funds rate affect other floating rate products.
- Average mortgage rates increased by 2% in 2022.
- An increase in the federal funds rate could lead to an increase in ARM rates.
- Additional Fed hikes are expected this summer.
In recent years, new home buyers have enjoyed some of the lowest mortgage rates in decades. This year, this trend has reversed and mortgage rates have continued to rise.
In 2022 alone, the average rate for a 30-year fixed-rate mortgage jumped 2%. New buyers are now looking at an average rate of 5.4% for the same 30-year loans.
And it can get worse from here. Just this week, the Federal Reserve announced an interest rate hike of 50 basis points – 0.50% – the biggest increase in more than 20 years. For consumers, this means that any debt based on the federal funds rate (a key index in many variable rates) could become more expensive.
ARM rates set to follow Fed hike
In the mortgage world, the most immediate response to the increase in the federal funds rate may be felt by those who have or are interested in an adjustable rate mortgage (ARM). Many ARM loans are indexed to the federal funds rate, which means they change as the rate changes.
Although the increase will not be immediate, ARM rates will likely respond to the Fed increase very soon. The impact this might have on you will depend on where you are in your ARM progression.
If you haven’t secured a loan yet, you’ll see higher rates when you shop around. If you already have an RMA, how long you’ve had it will be the most important factor.
Most adjustable rate mortgages have a fixed interest period at the start of the loan. For example, a 5/1 ARM will have a fixed interest rate for the first 5 years. Similarly, a 7/1 ARM has a fixed rate for the first 7 years. This fixed rate will not be impacted by the Fed’s increase.
Outside of this period, however, ARM loans are subject to annual rate adjustments. And the new rate you receive will most likely reflect the latest Fed increases. But wait, there’s more.
Further rate increases are likely to follow
While this week’s rate hike was a major deal, chances are it won’t be the last we see this year. Fed Chairman Jerome Powell indicated that the central bank was actively considering further rate hikes in June and July.
Each of these increases could reach half a percentage point. However, Powell also said rate increases larger than that were not being considered at this time.
This latest increase has already taken the federal funds rate between 0.75% and 1.00%. Further increases would take that rate from 1.75% to 2.00% – a big increase from the low rates of 0.25% to 0.50% we’ve had so far.
With additional increases apparently already underway, it could be late summer before many banks respond with their own rate hikes. Or, you may just see multiple increases after each meeting. Either way, it’ll probably be until late summer before most consumers start to feel the effects.
The impact of rate hikes on inflation remains to be seen.
It can help rule the housing market
If there’s one potential upside for homebuyers in all these mortgage rate hikes, it’s that they can help reign in the overheated real estate market.
Essentially, if it’s more expensive to get a loan, fewer people can afford it. This will mean fewer buyers, lessening competition – and, therefore, the power of sellers.
The sharp rise in mortgage rates could already have an impact on the housing market, as sales of existing homes fell in March. Housing prices also saw a slight decline.
For many, falling house prices – and bidding wars caused by fierce competition – can actually make buying a home After affordable, even if mortgage rates continue to rise. At the very least, it should become easier to to find a house to buy if they stay on the market longer.