Mortgage rates are changing all the time, and despite being lower than they were 20 years ago, the current trend shows that rates are going up. If you're already a homeowner, you may pay little attention to mortgage rate news --especially if you think your mortgage is unaffected by changes to the Federal Reserve.
However, depending on the kind of mortgage you have, a rise in the fed funds rate could result in major changes in your monthly mortgage payment.
What is the Fed Fund Rate and Why Does It Matter?
The fed funds rate is the interest rate set by the Federal Reserve. It determines the interest rate at which banks can borrow money from one another, and it sets a bit of a domino effect. The fed funds rate affects the prime rate, treasury bonds, and the Wall Street Journal Index --the three main indexes that lenders use for loans like credit cards and mortgages.
The Feds raise and lower the fed funds rate in response to the economy. Lowering it can help during a recession and raising it slows down inflation.
When it comes to your mortgage rate, lenders determine your interest rate by using one of these indexes as a base rate plus a margin. The margin is primarily based on the amount of risk associated with yourloan, such as your credit score, income-to-debt ratio, and your down-payment.
So, if all of this has to do with mortgage loans and you already have one, do rising rates affect you?
Fixed-Rate Mortgage
If you have a fixed-rate mortgage, the rate increase won't affect your current loan. That's one of the main perks of having a fixed rate! However, if you're thinking about refinancing to a new fixed-rate mortgage, buying a second home with a fixed-rate mortgage or taking out a home equity loan with a fixed rate, a rise in the fed funds rate will affect your monthly payment.
Adjustable-Rate Loans: ARMs and HELOCs
Adjustable rates are tied indirectly to the fed funds rate. Here's how the rise in rates can affect your loan: ARM loans have a fixed-rate initially, after which, the interest rate adjusts according to the index, just like we mentioned above. For example, a "5/1 ARM" has a fixed-rate for five years and then changes every year after that. " 7/1 ARM" loan has a fixed-rate for seven years and changes every year after that.
Just like a traditional fixed-rate mortgage, if the Fed raises its rates during your fixed period, yours won't change. But once you're in the adjustable period, you can expect it to go up within the year. On the other hand, if they lower their rate, you can expect yours to go down too.
The good news is, that depending on when your loan readjusts, you could have several weeks or months before the changes are reflected on your mortgage payments. Things are a little different with HELOCs.
Changes to the fed funds rate affect HELOCs sooner because they readjust quicker than ARM loans. So, unless you've secured a fixed-rate in advance, you'll see the effects of the rise fed rates on your mortgage payment.
Should You Be Concerned?
If you're in a fixed-rate mortgage, changes in the fed fund rate won't impact you much. However, if you have an ARM or HELOC loan, your payment could increase significantly.
Making changes now, or at least looking at your options, will save yourself time and worry about what the Feds plan to do next.
