Interest rates rose following a recent Federal Reserve announcement, and could continue higher as the new year kicks off.
On December 14, 2016, the Fed raised a key overnight bank-to-bank lending rate by .25 percent. Even though this is a short-term rate, it also impacts longer-term home loan rates.
Rates on 30-year fixed mortgages rose about .5 percent between the election and this Fed meeting — causing monthly payments on a $300,000 loan to rise $85 per month and payments on a $600,000 loan to rise $172 per month. The Fed cited inflationary concerns, and rising inflation causes rising mortgage rates. Accordingly, rates rose following the Fed decision and could continue higher to start 2017, albeit at a slower pace than from the election to present.
What does this mean for homeowners?
If you have a home equity line of credit (HELOC), your rate will rise by .25 percent on your next payment as a result of this Fed decision. On top of this, HELOC rates will rise three more times in 2017, according to the Fed’s guidance on December 14.
HELOCs are tied to a margin plus the prime rate, which is now at 3.75 percent. If you have a normal HELOC margin of about 2 percent, that means your HELOC rate will be 5.75 percent on your next payment, and will keep rising as the Fed hikes rates in 2017.
How much will it rise? Over the past 20 years, the prime rate has averaged 6.36 percent, and the high was 9.5 percent. It’s easy to forget prime was this high because it’s been 3.25 percent for seven of the last eight years, but if you add a 2 percent HELOC margin to a prime average of 6.36 percent, a HELOC rate would be 8.36 percent. On a $100,000 HELOC, this increases monthly interest cost by $218 per month.
If you compare this to a 30-year fixed rate second mortgage rate, the fixed rate is about 2 percent lower than the projected HELOC rate. On a $100,000 loan, this means a fixed rate second mortgage has about $167 less interest cost per month.
Switching to the fixed rate now will protect your budget later.
Also, even with first mortgage rates spiking .5 percent since November, there are still about 4 million homeowners who will benefit mathematically from a refinance of their first mortgage.
With home price increases in recent years, this means it’s also possible to eliminate your second mortgage by combining it with a new first mortgage.
What does this mean for home buyers?
Lenders use a debt-to-income (DTI) ratio to qualify you for a home purchase, which is calculated by dividing your housing and non-housing debt by your income.
On loans up to $424,100 (or $636,150 in high-priced areas), this DTI ratio can’t exceed 43 percent, and rising rates push this ratio higher. But not as much as you might think.
Rates have risen .5 percent since the election, which sounds like a lot, but it only adds about 1 percent to your qualifying DTI. Often you can make up for this 1 percent by paying down non-housing debt like credit cards instead of compromising on your home search by reducing your purchase price.
If you were previously qualified for a loan up to $424,100 (or $636,150 in high-priced areas) with a DTI well below 43 percent, you’re fine. If you were close to that threshold, it’s time to renew your pre-approval to make sure you still qualify for your target home price.
On loans greater than $424,100 (or $636,150 in high-priced areas), there are many options where you can get a loan with a DTI higher than 43 percent.
Ask your lender to review your options before 2017
Rate markets are finally starting to normalize after nearly a decade since the financial crisis. This means the economy is improving, which will continue to help the housing market improve.
But it also means it’s time to take a fresh look at your loan strategy before the market changes more — this goes for homeowners as well as buyers.
The holidays are very busy, but markets won’t wait for you. So talk to your lender about how these recent rate moves impact you, and how to get properly positioned.
About the author
Julian Hebron is a mortgage banking executive and writer based in San Francisco. He’s the editor of influential consumer finance and housing blog The Basis Point, and EVP of Sales with RPM Mortgage. His work is regularly cited by CNBC, The Wall Street Journal, and Marketwatch. Follow him on twitter: @thebasispoint