Are you in the market to buy a home? Whether you are a first-time home buyer, repeat homebuyer, or looking to sell your home to rent, this article is for you!
Below we summarize several things to keep in mind during a rising interest rate environment. Since My Financial Snapshot is the top personal financial statement provider online, there is a direct overlap between the mortgage application process and how rising interest rates affect your finances.
- What are federal reserve interest rates?
- How do home interest rates correlate with federal interest rates?
- Why are interest rates rising?
- When will interest rates come back to normal?
- How do interest rates affect buying a home?
- What is debt service?
- How can I prepare for even higher interest rates?
What are federal reserve interest rates?
The federal reserve interest rate sometimes referred to as the federal funds rate, is the interest rate commercial banks borrow from and lend to their customers. As of today, 7/13/2022, the federal funds rate is around 1.58% (Source: NYFED). For the most part, banks borrow money from the Federal Reserve to lend money out to the public.
How do home interest rates correlate with federal interest rates?
People sometimes ask what the federal reserve rate has to do with buying a home. I mentioned it in the question above, but banks borrow money from the Federal Reserve to lend money out to the public. For example, if a bank borrows money from the fed at a 1.5% interest rate, they may charge you a 5% interest rate. If a bank borrows money from the fed at a 0% interest rate, they may charge you a 3% interest rate. If you look at Rocket Mortgage website, you will see that the current interest rate on a 30-year fixed mortgage is 5.875%. As long as the federal reserve keeps increasing rates like they plan to, the more that rate will increase.
Why are interest rates rising?
While many factors go into why interest rates rise or fall. The primary reason for the increase in interest rates is to combat rising inflation. Have you noticed that the price of literally everything is going up? From basic needs like gas, food, and clothing to wants like vacations and concert tickets. We are coming out of a period of historically low-interest rates. Lowering interest rates during economic turmoil like recessions or a global pandemic is one of the ways the federal reserve tries to help the economy by making access to debt financing more affordable and accessible to businesses and consumers. See the chart below from the New York Times that shows the federal funds rate dating back to 1998.
When will interest rates come back to normal?
The honest answer to this is that no one knows. We have just begun to see rate increases, and there are no plans on slowing down from any of the central banks across the globe. One sign to look for is for the price of goods and services to level off and stop going up rapidly.
How do interest rates affect buying a home?
Let’s talk personal finance. Americans typically spend 30-40% of their take-home pay on housing. If someone makes $5,000 a month after taxes, they spend $1,500 to $2,000 on housing. Costs that go into housing are typically rent/mortgage payments, utilities, and insurance. Rising interest rates increase debt service and decrease purchasing power. See the graph below to visualize how increased rates increase your payment and reduce purchasing power.
What is debt service?
Debt service, as it relates to buying a home, is the interest you pay when you make your monthly mortgage payment. When interest rates rise, you pay more interest than at a lower rate. If you are on an adjustable-rate mortgage, keep in mind that the rate will be going up in the current rate environment.
How can I prepare for even higher interest rates?
There are ways to prepare for this. First and foremost is keeping a budget and knowing your numbers. Knowing your numbers will help you make the best decision. It may mean you have to buy a less expensive house or wait until there is a better time to purchase your next home. Good news. We have a budget tool to help you keep track of your income, investment, savings, and expenses.