We’ve enjoyed some very competitive interest rates over the past few years. This has helped the housing market not only recover but thrive in multiple markets across the country. Today, it’s common to find a 30 year fixed rate for a conforming loan amount in the 4.00% to 4.25% with some variance. These rates hit a record low back in late 2012 when the average 30 year rate hit 3.35% and have been on a very gradual rise since that time. One year later in 2013, that same rate registered at 4.46% and then drifting back lower in 2014-2017 as rates moved up and down in a very tight range. This has helped buyers more easily afford homes as financing costs have remained relatively stable. But rates are starting to move up and pushed past the 4.00% mark once again. This information is based on Freddie Mac’s monthly mortgage rate survey.
An increase in interest rates is a sign of a growing economy. However, when rates rise too fast, the Federal Reserve will step in and raise the Federal Funds rate. The Fed Funds rate has an indirect impact on mortgage rates the lenders use for their loan programs. The Fed Funds rate is the rate banks can charge one another for short-term loans. At the end of each business day, banks are required to have a certain amount of liquid reserves. These reserves are there to provide banking customers access to their accounts at any time. If a bank sees its reserve balance fall below the required minimum, it can borrow funds from others overnight to meet their reserve minimum. That’s the rate the Fed adjusts, not your mortgage rate.
But rate moves by the Fed provide some insight on future economic activity. One of the main reasons the Fed raises rates is to head off inflation. When there is too much money in the economy and consumers are feeling very confident about their situation and paying for goods and services at some stage businesses will see an opportunity to raise prices due to the increase in demand. Inflation means the dollar is worth less than it was and requires more dollars to buy the same exact good or service. Inflation robs consumers of wealth and the Fed is diligent about keeping a lid on it. The FOMC meets eight times per year in two-day meetings to discuss this very prospect along with other economic activity.
When the Fed raises rates, investors get a signal that the economy is growing. That means stock values for publicly traded companies can go higher and investors buy more stocks to take advantage of the anticipated value later on and profit from their actions. On the other hand, when the Fed decides not to raise rates during its FOMC meetings or takes action to lower the Fed Funds rate, it can signal a slower economy. If investors think the economy is going to slow down they’ll take a look at their investment portfolio and can make a determination to pull out some of their funds from stocks and into bonds. These investors can be individual investors or institutional investors. The theory is the same with a small investor or a large one.
Overall in 2018, the employment picture and both wholesale and retail inflation have been very favorable. More jobs are created yet prices are mostly remaining in check. The Fed likes to see consumer prices increase no more than 2.0% year-over-year. The economy wants an increase in prices, this is an indication of a healthy, stable economy, just not an overheated one. The Fed didn’t raise rates last January but did last December while announcing the likelihood of three more rate increases this year. We can then expect mortgage rates to follow to an extent. While the Fed may raise the Fed Funds rate by 0.75% this year, don’t expect to see mortgage rates follow in lock-step but instead rise and fall based upon the demand for bonds.
Interest rates for home loans are one of the most important features for any mortgage program. Higher rates mean fewer people can afford to buy the home they want. Higher rates can mean having to save up more money for a down payment and closing costs, delaying their purchase. Higher rates also reduce buyers purchasing power as they qualify for lower loan amounts with the very same income. Let’s take a look at how rates can affect affordability.
Let’s take a couple that makes $8,000 per month. They currently rent and are on the market for their first home yet they are very particular about the type of home they want and where they want to live. Their current debt load is two car payments, at $400 each. Common debt-to-income ratios are 33/43 for a typical loan. This means 33% of gross monthly income should be dedicated to the mortgage payment and 43% for total monthly credit obligations.
The housing ratio then needs to be 33% of $8,000, or $2,640. Property taxes and insurance payments are $640 per month, leaving $2,000 available for a mortgage payment. Using a 30 year fixed rate at 4.00%, that works out to a loan amount around $550,000. Now adding in the two car payments, the total debt ratio is 43%, right at acceptable levels. Any other additional payments would then reduce how much they can afford. Now let’s see how an increase in rates affects what they can afford.
At 4.25%, the loan balance would be $537,000. 4.5% gives us a $520,000 figure. All the way to 5.0%? The qualifying loan amount falls below $550,000 to $492,000. Just a 1.00% rate increase reduces the qualifying loan amount by around $58,000.
A 0.25% bump in rates will have an effect but a marginal one. Of course, “marginal” is a relative term. For someone that is already at or above the suggested debt ratios for a particular loan, even a 0.25% can have negative consequences. If this is you or someone you know, if you’re getting ready to enter the home buying market, don’t wait too long. With just two or three rate increases, it might mean putting more money down to get the home you really want.
Home buyers that have questions about any of the loan programs can contact Coast 2 Coast at the number above, 7 days a week.