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The good (and the bad) news about the next Federal Reserve rate increase

fed rate hike
Reading Time: 4 minutes
Feb. 12, 2018.

Barring a sudden downturn in our steadily growing economy, economists predict Federal Reserve policymakers will stick to their plan. Federal Reserve interest rates are likely to increase three times within the year, starting with the first rate hike expected in March 2018.

The Federal Reserve also raised rates three times in 2017, directly and indirectly affecting the job market, car loans, and credit card and mortgage rates. Now, CME data from early February predicts a 69 percent probability of a March rate hike, with a slight drop from previous estimates of 77 percent. Financial market conditions, along with signs of rising inflation, influence the Fed’s decision and are used to calculate this probability. Chief global strategists consider it unlikely that the Federal Reserve’s plans for a March rate increase will change.

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Expected Fed rate hike in March 2018: The good news

The Federal Reserve board’s plan indicates both good and bad news, says Brent Smith of Crestmark Mortgage Company.

First, the good news. Loan officers believe a potential Fed rate hike may lead to:

Further economic growth.

Raising the Federal Reserve rate shows that the Fed feels our economy has finally hit its stride again, Smith explains. “The chances of faltering are becoming less and less every quarter,” he says.

More job opportunities.

A stronger economy offers support for a stronger workforce. A stronger workforce, Smith says, can also open the door to future homeownership. “Stable and well-paying jobs can help with qualifying to buy a first home or to upgrade to a newer home due to the new opportunities the economy brings,” he explains.

Smith sees self-employed borrowers as one market in particular that may experience growth as consumers spend more on their businesses.

Housing prices may increase.

For homeowners looking to sell, this comes as welcome news. When the Federal Reserve increases the Fed Funds rate, it doesn’t necessarily directly impact long-term mortgage rates, Kelly Zitlow of Cornerstone Home Lending, Inc., explains. “However,” she says. “There are many factors that drive home loan rates, and the one having the biggest impact today is the Federal Reserve’s Quantitative Tightening plan announced in October 2017.”

As a result, Zitlow predicts that home prices are likely to increase with potential benefits for homeowners. “The Case Shiller Index is a great resource to track appreciation rates by state. Many are appreciating at 5 percent on average. That means that a $300,000 home today will cost more in the coming months,” she says.

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Expected Fed rate hike in March 2018: The bad news

On the other side of the coin, loan officers believe potential drawbacks of a Federal Reserve rate increase may include:

Mortgage rates may increase.

The only bad news, Smith says, would be mortgage rates increasing after being at historical lows for almost a decade. But for buyers, there’s more to the picture: A potential mortgage rate increase following a Fed rate hike isn’t guaranteed.

“A very common misunderstanding out there is that when the Fed raises the rates, this directly impacts mortgage rates,” Kelly Marsh of Cornerstone says. “This is not the case. Sometimes, rates improve after the Fed raises rates.”

The Fed Rate impacts the Prime Rate, Marsh explains, and is not tied to mortgage rates directly. Mortgage rates are tied to mortgage bonds and depend on how the bond market reacts to the Fed raising rates. Instead, Marsh says a Fed rate increase will directly impact home equity lines of credit, as well as credit cards and other consumer loans.

If mortgage rates do rise, Smith reminds buyers that the outlook is still positive. “Keep in mind that rates being anywhere under 6 percent are solid rates, but we have gotten very spoiled with rates being below 6 percent for so long.” At worst, Smith says borrowers may have to get used to the idea of paying “normal” mortgage interest rates again.

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Homeowners with ARMs may refinance.

Unlike fixed-rate mortgages, which may be indirectly affected, Marsh says a Fed Funds rate increase will impact adjustable-rate mortgages. “The Fed sets a target for the Fed Funds rate. This affects LIBOR, the rate banks charge each other for one, three, and six-month loans, as well as the Prime Rate. For these reasons, the Fed Funds rate impacts ARM loans.” The higher the LIBOR is, the higher the ARM rate will be, Marsh explains.

When this occurs, Smith says homeowners with ARMs may need to take a look at their current situations. It could make sense to refinance before rates increase again over the next 1 to 2 years.

Zitlow agrees, adding that the 1-year LIBOR Index was 1.72 percent a year ago and is currently about 2.29 percent. This rate difference of 0.57 percent will directly impact the home loan ARM rate once it adjusts, she says.

“Homeowners should consider how long they’re keeping their current home and when the ARM will unlock,” says Smith. “The trend is most certainly upward. Homeowners who want to avoid unlocking into a higher rate economy will bite the bullet and refinance now. This could secure a fixed long-term rate if they will be keeping the property over 4 to 5 years.”

Weighing the potential effects of an anticipated Fed rate increase, loan officers believe homeowners and buyers are in good standing. “Though home loan rates have increased from years past, they’re still historically low,” Zitlow says. “Anyone waiting to buy may encounter two components that may lead to higher payments: higher interest rates and higher home prices.”

For educational purposes only. Please contact a qualified professional for specific guidance. 

Sources are deemed reliable but not guaranteed.