The Federal Reserve raised a short-term interest rate this week, making it more expensive to borrow money to buy a house or fix it.
All in the name of slowing inflation.
The central bank on Wednesday raised the federal funds rate by 0.5%, or half a percentage point. The Fed had not raised the federal funds rate by half a percentage point in a single meeting since 2000.
The 0.5% increase is seen as a “hawkish” or aggressively anti-inflationary measure. Prominent Fed officials had been hinting for weeks that they would raise rates bigger than usual, and mortgage rates had already risen sharply in anticipation, climbing about three-quarters of a percentage point from mid-March to the end of April.
“The rhetoric that’s been going on over the past few weeks has all been about a much more hawkish stance, and that’s really where this interest rate hike has happened,” says Selma Hepp, deputy chief economist for CoreLogic, a provider of real estate information and analysis.
The effect of the Fed on mortgage and stock rates
The Fed increase will cause other interest rates to rise, some directly and some indirectly.
A higher federal funds rate will directly increase the rates charged on adjustable rates home equity lines of credit. They will increase by 0.5% in a billing cycle or two. These loans, also called HELOCs, are often used to pay for home renovations.
The Fed also has an indirect impact on mortgage rates, which rose steadily in March and April because the markets knew this increase was coming. Mortgage rates should continue to climb, as the Fed has only raised the fed funds rate twice this cycle and markets are expecting several more hikes.
Lawrence Yun, chief economist of the National Association of Realtors, noted that the 30-year mortgage rate has risen much more this year than the federal funds rate. “This implies that the market is already valuing around eight to 10 series of [Fed] rates are rising this year,” Yun said in an email. “If inflation rises, the Fed will have to be even more aggressive, which will push mortgage rates even higher. “
How expensive mortgages reduce inflation
Typically, the Fed raises the federal funds rate 0.25% at a time. But no one would call today’s economy typical. The consumer price index, a gauge of inflation, hit 8.5% in March, its highest level in more than 40 years. The Fed is showing that it is serious about curbing inflation by raising the federal funds rate to twice the usual increase.
“We are really committed to using our tools to get inflation back to 2%,” Fed Chairman Jerome Powell said April 21 during a roundtable presented by the International Monetary Fund.
You might consider raising the costs of buying a home as a weird way to control runaway price increases. But higher mortgage rates could put a damper on the rapid rise in home prices, as many homebuyers are buying with a monthly payment in mind. As mortgages become more expensive, homebuyers may be forced to shop around for cheaper homes, which could slow the pace of home price increases and, therefore, dampen inflation.
Let’s take the hypothetical example of someone who can afford $1,700 a month for mortgage principal and interest, and who started shopping for a house in February. At the time, the 30-year fixed rate mortgage averaged around 4%. Let’s say our house hunter finally made a successful offer at the end of April, when the 30-year mortgage rose to around 5.25%. Here’s how the rate increase affects how much this buyer can afford to borrow:
At 4%, the buyer can afford to borrow $356,100.
At 5.25%, the buyer can afford a mortgage of $307,900, a loss of borrowing capacity of $48,200.
HELOC borrowers and home sellers are not spared
Higher interest rates affect more than homebuyers. They are also changing the calculations for HELOC borrowers and home sellers.
Interest rates on variable rate HELOCs are tied to the prime rate, which moves in parallel with the federal funds rate. Homeowners with balances on their HELOCs may see their interest charges increase as the interest rate increases. For every $50,000 owed on a HELOC, a 0.5% increase in the interest rate increases the monthly interest by $20.83.
Door-to-door sellers should keep in mind that higher mortgage rates reduce affordability. It might be worth checking to see if pre-approvals from buyers are based on current mortgage rates instead of lower rates from a few weeks ago.
And with fewer people able to afford homes at today’s higher mortgage rates, sellers may find they can no longer rely on multiple offers. This situation is worth considering when setting an asking price.
May Mortgage Rate Forecast
Mortgage rates are more likely to rise than fall in May as the Federal Reserve could send signals that it will continue to raise short-term interest rates in half-percentage-point increments when of its June and July meetings. If the central bank continues this kind of aggressive approach to monetary policy, mortgage rates will almost certainly rise to keep pace.
If, on the contrary, mortgage rates fall, the most likely cause would be a geopolitical crisis.
what happened in april
At the end of March, I predicted that mortgage rates would continue to rise because they hadn’t stopped rising. This forecast was equivalent to looking out of an airplane window three minutes after takeoff and predicting that the plane would continue to climb for some time. In other words, I did not base the prediction on in-depth analysis. I metaphorically looked out the window.
I guessed correctly. Mortgage rates have skyrocketed. The 30-year mortgage rate averaged 5.09% in April, up from the March average of 4.37%.
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Holden Lewis writes for NerdWallet. Email: firstname.lastname@example.org. Twitter: @@HoldenL.
The article Why the Fed Wants Homebuyers to Face Higher Mortgage Rates originally appeared on NerdWallet.