What happens when interest rates go up? That’s a tricky question. On Dec. 14, 1016, the Federal Reserve Board announced a 0.25 percentage-point increase in the federal funds interest rate, to 0.75 percent. This was viewed as a good thing because it indicates the Board’s confidence in a resurgent and growing U.S economy.
The Federal Reserve is where big U.S. banks have reserve funds. So, when the Federal Reserve Board announces a decision about interest rates, it’s big news. Naturally, any fluctuation in that prime rate affects all kinds of interest rates, including those on credit cards, savings accounts, investment strategies — and, yes — mortgage rates.
If you’re an aspiring or soon-to-be new homeowner, rising, flat or falling mortgage rates can affect how much you’ll pay for your home and the amount of your monthly payments.
But, don’t view it as a discussion of dusty financial information. Here are a few takeaways for when the Federal Reserve Board next tinkers with the federal funds interest rate.
Two Kinds of Mortgages
Unless you’re fortunate enough to pay for your new home in cash, you’ll finance it. This means choosing between a Fixed Rate Mortgage (FRM) or an Adjustable Rate Mortgage (ARM). A Fixed Rate Mortgage means its interest rate won’t change during your mortgage. Neither will the amount of your monthly payment. An Adjustable Rate Mortgage begins with a fixed interest rate for a designated number of years, after which the interest rate rises or falls with the financial markets. This means your monthly payments will do the same.
How Interest Rates Affect Mortgages
If you’re risk-averse, a Fixed Rate Mortgage might be a good choice. Once you lock in your mortgage interest rate, it won’t change no matter how much the financial markets fluctuate. You can budget for the same payment amount each month. If you’re comfortable with risk, an Adjustable Rate Mortgage might be a good choice. You might have higher or lower payments after your opening period of a fixed interest rate expires. If the Federal Reserve Board continues hiking the prime rate, other banks and lending institutions will continue hiking their interest rates to reflect the federal rate hikes. This could affect your monthly budget.
Think an Adjustable Rate Mortgage will work for you? A useful exercise is sketching out in advance how possible future interest-rate hikes could “hike” your monthly mortgage payment. You’ll have to do a bit of theorizing and playing what-if, but crunching those rough numbers, then comparing them to your annual income and monthly bill payments, should give you a real sense of whether you can be elastic along with an Adjustable Rate Mortgage. It also can help you determine your pain point on fluctuating interest rates — i.e., when it’s time to ditch the Adjustable Rate Mortgage and shift to a Fixed Rate Mortgage.
Don’t Halt Your Home Shopping
Yes, interest rates appear to be rising, with mortgage rates among them. Still, don’t abandon your plan for finding your dream home and procuring a mortgage. Your household’s goals and resources are better barometers for your process rather than hand-wringing over interest rates.
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