The Federal Reserve hiked the Fed Funds Rate from 0% to .25% today for the first time in nearly 9 years. There is a lot of talk about this but what does it really mean for you?
What is the Fed Funds Rate?
The interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight. The federal funds rate is generally only applicable to the most creditworthy institutions when they borrow and lend overnight funds to each other. The federal funds rate is one of the most influential interest rates in the U.S. economy, since it affects monetary and financial conditions, which in turn have a bearing on key aspects of the broad economy including employment, growth and inflation. The Federal Open Market Committee (FOMC), which is the Federal Reserve’s primary monetary policymaking body, telegraphs its desired target for the federal funds rate through open market operations. Also known as the “fed funds rate”. (Source Investopedia)
What does this mean for mortgages?
In the near term, mortgage rates will be volatile, but I suspect that rates will remain around 4% for the coming months. Interest rates at 4% are still historically low and still present a great opportunity to homebuyers. Most, if not all, of the rate hike has already been priced into mortgages so you will not see any dramatic changes.
Additionally, the Fed only controls short-term interest rates. Mortgages are based on long-term interest rates. The Fed has indicated that they will expect only “gradual increases” in rates next year and will continue to review economic data to determine any additional rate hikes. Many economists see the Fed ending 2016 with a rate of 1%.
Those with adjustable rate mortgages will see the change when their rates adjust. The small hike today will not amount to much, but if the Fed continues to hike rates in the coming year, the difference will become more noticeable.
What does this mean for home prices?
A lot of potential homebuyers have been waiting for a relief in home prices, especially given the historical increases in home prices we have seen in the past few years. I see the increase of interest rates two ways:
1) Buyers may gain a sense of urgency as the reality of higher interest rates is staring them right in the eye. This may bring on a new rush of homebuyers into the market fearing they will miss out.
2) As rates increase, mortgage payments will increase, thus buyers will have less purchasing power. This will push some buyers to the sidelines because they simply cannot afford the home they desire anymore. In this scenario, I believe the rate of price increases will decelerate or even turn negative. That being said, I do not believe this will lead to a dramatic drop in home prices, but this will help stabilize a heated market.
In Summary
Overall, the Fed increasing interest rates is a good sign for the economy. Unemployment is near 5%, which has traditionally meant “full employment”, the economy is growing, and the prospects going forward look good. For now, the rate increase will not do much to affect your daily lives, but as we experience further rate increases, the cost of borrowing will continue to increase.