In its fight against crazy high inflation, the Federal Reserve (aka the Fed) raised interest rates in December for the seventh time in 2022—boosting them by half of a percent.1
That’s a big deal for people who want to buy a house because when the Fed raises rates, it usually means mortgage interest rates go up too. And that’s exactly what happened in 2022, when the average interest rates for 30-year fixed-rate mortgages more than doubled from around 3% in December 2021 to over 7% at its highest point in 2022.2 Woah!
If you’re like most people, you may have some questions about what’s happening—like, How do Fed interest rates affect mortgages? After all, interest rates don’t just impact the real estate market—they impact real people like you.
So, let’s get you some answers. Here’s a look at how interest rate hikes affect . . .
How Do Federal Interest Rate Hikes Affect Mortgages for Home Buyers?
When the Fed raises interest rates, mortgage rates almost always go up too. And a mortgage lender won’t lend you as much since higher interest rates increase your debt-to-income ratio—that means you’ll have less buying power when you’re shopping for a house.
Let’s see how this plays out for two couples.
Both couples bought $350,000 houses with 20% down and 15-year fixed-rate mortgages. (15-year mortgages are the best option because you’ll pay way less in interest over the life of the loan and you’ll pay off your house a lot faster.)
So, Jim and Donna bought their house in December 2021 when the typical interest rate was 2.34%. Bob and Cheryl bought their house a year later—after the average rate rose to 5.54%.3
We used our mortgage calculator to see what both couples will pay for their houses. To keep things simple, we left out costs for property taxes, homeowners insurance and homeowners association (HOA) fees.
|
Jim and Donna’s House |
Bob and Cheryl’s House |
|
|
Home Value |
$350,000 |
$350,000 |
|
Down Payment |
$70,000 |
$70,000 |
|
Loan Amount |
$280,000 |
$280,000 |
|
Interest Rate |
2.34% |
5.65% |
|
Monthly Payment |
$1,846 |
$2,310 |
|
Total Interest Paid |
$52,280 |
$135,800 |
|
Total Cost |
$402,280 |
$485,800 |
Bob and Cheryl will pay over $80,000 more in interest than Jim and Donna—even though their home value and loan terms are the same. Plus, Bob and Cheryl’s house payment is $448 more per month. Ouch!
Should You Buy a House Right Now?
Numbers like that can be hard to swallow. But does it mean you shouldn’t buy a house? It depends on your financial situation.
If you have consumer debt—like a credit card balance, student loans or a car payment—you should focus on paying that off before you buy a house. You also should kick buying a house down the road if you don’t have a fully funded emergency fund worth 3–6 months of your typical expenses.
Why? If you have to make payments on debt in addition to your house payment, you’ll feel like you’re drowning. Not only that, but it’ll also be hard to find room in your budget to accomplish other important financial goals, like investing for retirement and saving to help pay for your kids’ college.
And if you don’t have enough cash set aside for emergencies, you’ll have a crisis on your hands the first time something goes wrong with the refrigerator or HVAC unit—and trust us, something will go wrong.
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So, what if you are debt-free and do have a full emergency fund? In that case, now is actually a great time to buy a house. Sure, the interest rates and home prices are high, but they’re only going to keep climbing. And because interest rates are high right now, fewer folks are buying—that means you won’t have as much competition when you make offers.
Plus, when and if interest rates do eventually go back down (we’re talking years here, by the way, not months), you can always refinance your mortgage.
Just make sure you’ve saved enough to make at least a 5–10% down payment—though 20% is even better because it’ll keep you from paying private mortgage insurance (PMI). And your mortgage payment (including property taxes, insurance and HOA fees) shouldn’t be more than 25% of your take-home pay.
How Do Federal Interest Rate Hikes Affect Home Sellers?
Alright, we’ve covered the basics of how the latest interest rate hike affects home buyers. Now, let’s get into the impact on home sellers.
Should You Wait to Sell Your House?
Whether you sell your house now or later is completely up to you! If you don’t want to, you definitely don’t have to. But if you’re ready to sell your house, go for it. Some buyers may back out of the market, but others are ready to dive in. Focus on doing things that’ll attract them and help your house sell faster.
For example, you can stage your home better, get honest about the real reasons buyers aren’t interested, and avoid home-selling mistakes like asking too much or hiring the wrong real estate agent. Finally, be patient and trust your real estate agent to bring you the right buyers at the right time. Speaking of agents . . .
Finding a Good Real Estate Agent
If you’re ready to sell your house (or if you’re buying), you need an expert real estate agent who knows the market in your area. That’s why we created the Endorsed Local Providers (ELP) program.
The ELP program helps connect you with top-performing, local RamseyTrusted real estate agents. They’re pros on a mission to serve you—even if it means less money in their pockets. They’re RamseyTrusted because they put you first. Period.
Find a RamseyTrusted real estate agent today.
How Do Federal Interest Rate Hikes Affect Current Homeowners?
Okay, we’ve talked about home buyers and sellers. But what if you already have a mortgage? Do changing interest rates affect you too?
They can! Let’s take a look at how the Fed’s decisions affect current homeowners who have these types of mortgages: fixed-rate conventional loans, adjustable-rate mortgages (ARMs), and home equity lines of credit (HELOCs). We’ll also talk about whether you should consider refinancing based on the type of mortgage you have.
Fixed-Rate Conventional Loans
If you have a fixed-rate mortgage, here’s some good news: Your interest rate won’t change, and neither will your monthly mortgage payment! (You can breathe now.) That means refinancing isn’t for you—at least for now. It would be almost impossible to get a better rate.
Luckily, there’s a foolproof solution to that problem: Don’t go into nonmortgage debt. And if you already have nonmortgage debt, get rid of it. Zero debt equals zero interest.
Adjustable-Rate Mortgages (ARMs)
With an ARM, or adjustable-rate mortgage, your lender raises or lowers your interest rate—and in turn, your monthly payment—based on an index interest rate that changes constantly and is tied to a bunch of market conditions.
So, if the Fed raises the federal funds rate (we’ll talk more about what that is later) by 0.5% and other rates follow suit, your rate will probably go up 0.5% too. (And good luck getting it back down.)
Many ARM lenders adjust interest rates every 6–12 months, so the good news is, you may have a few months before your lender changes anything. The bad news? Your lender could wait for the Fed to raise rates a couple of times, then hit you with a huge increase.
Moral of the story: Don’t wait around for your lender to raise your rate. Refinance to a 15-year fixed-rate mortgage now to give you and your family some financial breathing room.
Home Equity Lines of Credit (HELOCs)
A HELOC (or home equity line of credit) is a combination of two dumb things: a credit card and a second mortgage. Like a credit card, a HELOC lets you borrow money and pay back a little at a time. And like a second mortgage, you’re borrowing that money against your house . . . so if you can’t pay what you owe, the lender can take your home.
That’s scary. But it gets worse. Most HELOCs have variable interest rates—and they can change more often than ARM rates. So anytime the Fed sneezes, your rate will go up.
Talk about stressful! If you’ve got a HELOC, you need to pay it off ASAP.
What Is the Federal Reserve?
Okay, we’ve talked a lot about how the Fed’s interest rate hikes can affect you, but what is the Fed anyway? Well, the Federal Reserve is the U.S. central bank that creates money and sets interest rates. Its main goal is to keep the economy running smoothly by having low unemployment and low inflation.
The Fed is kind of like a mechanic who tinkers around with a car to make it purr like a kitten, and one of its favorite tools is (shocker) interest rates.
Why Is the Fed Raising Interest Rates?
The Fed raises interest rates to encourage people to borrow less, spend less and save more—which should slow down inflation.
Now, the Fed doesn’t tell commercial banks what interest rates to charge on loans, but they do influence the banks’ rates by setting their federal funds rate. The fed funds rate is the interest rate banks charge to each other for overnight loans, and it influences most other interest rates.
So, even though the Federal Reserve doesn’t actually set mortgage interest rates, its decisions can still affect your mortgage—and it can impact other areas of your finances too.
Mortgage rates went up in early 2022—even before the Fed started raising rates. That’s because banks saw what was coming and started upping interest rates to protect their profits.
The Bottom Line
No one likes it when interest rates go up, but it’s not the end of the world. This is still a great time to buy a house—you just might pay a little bit more than you would’ve a few months ago. It’s also a good time to sell a house. And if you already have a fixed-rate mortgage locked in, you’re in good shape too.
Don’t listen to the doom and gloom that’s all over the internet and in the news. Owning a home is still more than possible, and you still control your financial future.
Work With a Mortgage Lender You Can Trust
While it’s smart to get the lowest possible interest rate on your mortgage, that doesn’t mean you have to wait years to buy or sell a house—or to refinance if your current loan just isn’t working for you. You get to make decisions based on what’s right for you and your family, not what the Fed is doing.
Work with a smart lender who actually wants you to get the best mortgage for you. Our friends at Churchill Mortgage will help you find a home loan that works with your budget and puts you on a path to pay off your house fast.
Talk to a RamseyTrusted mortgage expert at Churchill.
