For years, the prospect of a higher national interest rate loomed over the heads of prospective homebuyers. Now that the Federal Reserve decided to increase the federal interest rate in December — the first time since the 2008 financial crisis — its important to know how the recent and future rate hikes will affect your mortgage rates.
Effects of the Fed Hike
The Federal Reserve sets monetary policies by buying and selling Treasury bonds to increase or decrease the federal interest rates. The ripple effect of interest rates on Treasury bonds affects all types of loans, including mortgages, car loans and credit cards. Rising interest rates may affect you whether you have an existing home loan, are in the market to buy a home, or are hoping to refinance your mortgage.
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Existing Fixed-Rate Mortgages
If you have a fixed-rate mortgage already locked in, your rate is secured for the term of your mortgage regardless of how the Federal Reserve changes rates. You're also protected if you have a rate lock for a mortgage that you're taking out in the near future. For example, if you have a 45-day rate lock, even if the Federal Reserve raises rates, yours won't change as long as you take out the mortgage within the allotted time.
Adjustable Rate Mortgages
If you have an existing adjustable rate mortgage, when rates rise, you're likely to see your rate go up as well. The amount of the increase depends on how much the Federal Reserve raises the rates, and it could become substantial if rates continue to rise over time.
If you have an interest rate cap on your adjustable rate mortgage, your increases could be held in check. For example, a lifetime cap of five percent means that your rate can't increase more than five percent over your initial rate. A periodic cap of one percent means your rate can't increase by more than one percent each time the rate is adjusted.
Future Home Buyers
If you're in the market for a mortgage, a Federal Reserve rate hike can mean the loan for your new house is going to cost more than you expected. As market interest rates rise, so will mortgage interest rates. Pre-approval for a mortgage is not the same as a rate lock. If rates increase between the time you're pre-approved and when you actually close, you could get the higher rate.
Refinancing Your Home
Although your existing mortgage might have a fixed rate, that fixed rate won't matter if you refinance your mortgage. When you refinance, you are essentially taking out a new loan to pay off your existing mortgage. Refinance lenders won't look at what you're paying on your current mortgage when you apply to refinance.
For example, if Federal Reserve rate hikes caused market rates to increase by two percent since when you took out your mortgage, you'll likely be offered an interest rate that’s two points higher when you refinance. If you need to tap into your home's equity after rates go up, consider a home equity loan on top of your existing mortgage so the higher rate will only apply to the home equity loan, not your entire refinanced mortgage.