Written by Carissa Abazia

As a lender, I get asked: When will rates rise? What will the new ARM rate be when it is adjusted? And many more like questions.

As a mortgage lender, it’s important to have answers to these questions.  It’s also important to know when and why rates might increase. However, without a crystal ball, we cannot actually determine when rates will rise or fall.  The best we can do – and the best lenders do this – is follow the market and listen to the Chairman of the United States Federal Reserve when he talks.

Movements in financial markets drive mortgage rates. When the economy heats up, bond prices drop and as a result, rates increase. When the economy pulls back, interest rates tend to fall.  When the Feds buy less, rates bump up.

Therefore, good economic news tends to be bad news for interest rates. An active economy raises concerns about inflation. Inflation causes fixed-income investments like bonds to lose value, and that causes their yields (another way of saying interest rates) to increase.

What is an interest rate?

An interest rate, in the simplest of terms, is the cost of borrowing money. You pay interest for the ability to spend money “now” rather than wait until you have saved that amount.

With every loan, there’s a risk that the borrower won’t be able to pay it back.

The higher the risk that the borrower will default (fail to repay the loan) is, the higher the interest rate. A borrower’s credit score is one of the risk factors that affect interest rates. Therefore, maintaining a good credit score will help lower the interest rates offered to you by lenders, creditors, dealerships, etc.

Why is your credit card interest rate much higher than your mortgage?

A mortgage is secured credit: if the borrower defaults on the loan, the bank can always take the house. Credit cards are unsecured credit: there’s no collateral backing the loan, only the cardholder’s credit score. Mortgage interest rates are typically much lower than credit card interest rates because they’re less risky for the lender.

Rate History: Highs and Lows

The Federal Reserve prefers to keep the fed rate between 2 and 5 percent. It’s the sweet spot that maintains a healthy economy. Between 2 and 5 percent, the nation’s gross domestic product (GDP) grows between 2 percent and 3 percent annually.

Highest Fed Funds Rate

In 1973, inflation tripled, from 3.9 percent to 9.6 percent. The Fed only doubled interest rates from 5.75 to a high of 11 points. Inflation continued to remain in the double-digits through all of 1974, lasting until April 1975. The Fed kept raising the fed funds rate to a peak of 13 in July 1974, and then dramatically lowered the rate, reaching 7.5 by January 1975.

The fed funds rate reached a high of 20 points in 1979 and 1980 as a way to combat double-digit inflation.

These sudden changes, known as stop-go monetary policy, confused businesses. Corporations and small business owners kept prices high to stay ahead of the Fed’s interest rate spikes.

That only made inflation worse.

Fed leaders learned that managing inflation expectations was a critical factor in controlling inflation itself.

Lowest Fed Funds Rate

The all-time low was 0.25 percent. That’s effectively zero. The Fed lowered it to this level on December 17, 2008, the tenth rate cut in a little over a year.

The Fed didn’t raise rates again until December of 2015.

Before this, the lowest fed funds rate was 1.0 percent in 2003, to combat the 2001 recession. At the time, there were fears that the economy was drifting towards deflation.

What’s Happening Today

For the better part of 2017, the stock market was on the rise, the economy was growing, interest rates were low, and inflation wasn’t a huge concern. That smooth ride may be coming to an end.

A recent report showed that the strong economy might be resulting in rising wages. While rising pay is good for workers, it’s usually a sign that inflation is knocking at our door.

And if inflation is coming, the Federal Reserve is likely to raise interest rates to slow down the economy and cool off the inflation.

Rising rates have a myriad of consequences, including making it more expensive for individuals to borrow money.

When the Fed raises interest rates, bonds become more attractive, so people move money from stocks to bonds — and the stock market dives. It becomes harder to borrow, so businesses and homeowners have less capital to throw around.

Although it’s a change after a decade of “easy money” – super low interest rates – from the world’s central banks, we need to keep in mind that it’s still cheap money. Since 2009, we have seen some of the lowest global interest rates; this may be the reason why interest rates between 4.5% and 5% are causing stress and angst.  It’s easy to forget that interest rates were between 8% and 20% not too long ago.

If we start to see growth slowing and inflation rising, that’s when we need to be concerned.  As long as growth continues to improve, a little inflation isn’t too big of a concern.

And for residents of Sonoma County, our economy is projected to see stable growth this year even in the aftermath of October’s fires. There is such a high demand for homes in this area.  Higher rates may dampen the sale of cars, but in my opinion, not the sale of homes with inventory as lean as it is.

In Conclusion…

Mortgage rates remain very favorable for anyone considering homeownership. Residential financing is still affordable.

In a rising rate environment, the decision to lock or float becomes complicated.  This past week has been so volatile that my company is focused on improving pricing.  We didn’t lock in too many clients for this reason (only with short closing windows).

Mortgage rates yesterday were fairly stable, and there have been no significant economic releases. I am constantly watching the market and staying in contact with my clients. Make sure your lender is doing the same for you.

It’s Still Cheap Money

Here is a case for a cash-out refinance in exchange for a slightly higher inerest rate…

John has $40,000 on credit cards with an APR of 28% and a car loan of $30,000 with an APR of 5%.

**The minimum payment on credit card debt is calculated as a percentage of your total current balance. It varies by creditor.  In this example let’s say it is 2% of the balance on his credit cards**

Therefore, every month John shells out a minimum of $800 to pay down credit cards in addition to a monthly car payment of $566.  That’s a total of $1,366 a month.

John’s home is worth $500,000 and he owes $300,000.  His current interest rate is 4.00% and his monthly payment is $1,960.  In total, John is shelling out $3,326 a month (credit cards + car loan + home loan).

John decides to refinance and takes out $100,000 from the equity in his home.  His new loan amount is $400,000 and the interest rate is 4.50%.  His new monthly payment is $2,540 for a 30-year fixed loan term.

John pays off his credit card debt of $40,000 and his car loan of $30,000, saving him $786 a month ($3,326 – $2,540).  After John pays closing costs, he has a remaining ~$27,000 to put in his savings account.

Not a bad deal if you ask me!

 

Thanks for reading!

Carissa Abazia

@CarissaMortgage