Rising Interest Rates Might Boost Your House Payments
March 28, 2006 — -- The Federal Reserve's decision last month to raise a key interest rate by one-quarter point could pressure homeowners who hold adjustable-rate mortgages and others who have taken out home equity loans, but the vast majority of homeowners will not see their monthly payments affected.
The Fed raised the federal funds rate -- the rate banks charge for overnight loans -- to 4.75 percent. The announcement marks the Fed's 15th interest rate increase since June 2004. The rate hike also increases the prime rate, the benchmark for millions of home equity and other consumer and business loans. The prime rate stood at 7.5 percent before this week's meeting and rose to 7.75 percent with the Fed's most recent interest rate increase.
Long-term loan rates, like mortgages and student loans, are less directly affected by the Fed's moves because they are tied to the bond market. These rates tend to use the fed funds rate as an indicator of trends -- when the short-term rates go up, historically, long-term rates follow. Long-term credit instruments like mortgages have historically moved in the same direction as short-term interest rates, but the housing industry has seen less of that during this 20-month tightening cycle.
That doesn't mean that the Fed's decision won't affect anyone.
The adjustable-rate mortgage has become very popular in the past five years, as buyers have looked to capitalize on the low introductory rates often offered with ARMs. Now, as interest rates continue to rise, people with ARMs can be hurt indirectly by the Fed's decision.
"Because the market has anticipated the Fed raising rates again, some of that might already be factored into the adjustable rates," said Frank Nothaft, chief economist with Freddie Mac. "The initial interest on adjustable-rate mortgages will see some upward movement but probably not the full quarter-point."
Homeowners who have taken out home equity loans will see their rates jump immediately with the prime rate. Home equity lines of credit, in which you borrow against the value of your home, are tied to the fed funds rate. But home equity loans tend to be for much smaller amounts than the total value of a home, typically ranging from $15,000 to $25,000.
Nothaft said that about 85 percent of single-family U.S. homeowners in the prime market had long-term, fixed-rate mortgages that would remain the same despite the Fed's decision.
"The vast majority of homeowners who have fixed-rate mortgages probably won't be affected at all," Nothaft said.
Related Stories
ABC News Live