What Should Mortgage Seekers Do If The Federal Reserve Raises Lending Rates?

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So you are in the process of buying a house, but suddenly you hear that the Federal Reserve is going to raise interest rates? What should you do?

What Causes Mortgage Rates to Increase?

Before panicking, look at what actually drives mortgage rate increases. The majority of mortgages are fixed-rate mortgages, for fifteen or thirty years. Adjustable rate mortgages are a different animal and fluctuate based upon the market rates, so those don't apply as much to this discussion.

The Federal Reserve adjusts the federal funds rate, which is the rate that banks charge each other when they loan money between banks. Changes to this rate have a far greater effect on short-term loans, such as auto loans, than on long-term loans. 15-year, fixed rate mortgages are actually based upon the yield of 10-year Treasury notes, not the federal funds rate.

Other factors have more influence on changing mortgage rates than the federal funds rate such as:

  • Steady job growth: this creates stability in the lending market, as lenders with good job history are expected to be able to pay their mortgages
  • U.S. economic growth: if the economy is growing, then lenders expect more people to have jobs and be seeking to purchase houses, leading to competitive mortgage rates
  • Economic inflation: the Federal Reserve adjusts rates to respond to an expected rise or fall in inflation. As inflation rises, mortgage rates rise.
  • Treasury bonds: 10-year Treasury bonds are closely linked to 15-year mortgages. As Treasury bond yields increase, so do 15-year mortgage rates

What Should You Do?

The easiest answer is that you shouldn't do anything you aren't already doing while you look for a house. Mortgage interest rates are much more closely tied to larger, macro-economic forces, not the movement of the Federal Reserve. An expected rate hike should not make you hastily seek a house to buy or stop looking for a house.

If you like the rates that you are seeing now, you can lock your interest rate early once you are qualified for a loan. This only works if you have decided upon a house already, since you can't lock a rate without knowing the purchase price. The interest rate you can lock is dependent upon how many days you need to hold that interest rate. You need to determine how long it will take you to close on a house and then request a loan lock that is a bit longer than that period.

There are costs associated with locking a loan rate early. To hedge risk, lenders may charge fees or offer slightly higher rates to lock the loan early. These fees and rates are higher the longer the lock period.

The most important thing to do is to remain calm. Small moves in the federal funds rate have small impact on fixed year mortgage rates. Even if they do go up, you may not be looking at much more per month with the higher rate.