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Will Rate Hikes Tank the Market?

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Posted On: 12/02/2015

Question:

The Federal Reserve is expected to hike interest rates in December. If that happens will it sink the real estate market?

Answer:

Several times during the past year many predicted that the Federal Reserve would raise rates and nothing happened. As this is written before the December Fed meeting, there is no way to tell what will happen or not happen.

However, let’s imagine that the Fed does raise rates. The usual suggestion is that rates will increase by .25 percent. How will this impact the real estate marketplace?

First, it should be said that the Fed does not directly impact mortgage rates. The Fed has the ability to raise and lower certain costs for banks and those expenses get passed through to borrowers in the form of higher or lower rates for bank loans.

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Second, the expectation is that if the Fed raises interest rates for banks that mortgage rates will surely follow. However – and this is a crucially important point – that may not be the case because mortgage lenders do not necessarily get money from the banking system. For instance, there’s an estimated $3.6 trillion that now earns negative interest in Europe and Asia. If bank rates rise mortgage lenders might want to get capital from other sources – sources that might be elated with returns that are lower than today’s rates.

It might seem strange to suggest that mortgage rates could stay level and perhaps even decline if the Federal Reserve raises rates. However, the end of the Fed’s quantitative easing program also was supposed to raise mortgage rates, and when the Fed finally ended its massive security purchases in October 2014 mortgage rates nudged up for a few weeks and then quickly fell back. According to Freddie Mac, mortgage rates at the end of October 2015 stood at 3.76 percent for fixed-rate 30-year financing versus 3.98 percent at the end of October 2014.

But what if the Fed does raise interest rates by .25 percent in December and mortgage rates increase by a similar amount?

If someone wants a $150,000 fixed-rate mortgage and the interest rate goes from 3.75 percent to 4 percent, it means that the monthly payment will increase from $694.67 to $716.12, a difference of $21.45 a month.

In the context of a $150,000 mortgage $21.45 is not a lot of money, however it is enough to sink marginal loan applications, and inherently higher rates are simply not good for real estate. Also, once the Fed finally does begin to raise bank rates it’s likely that there will be a series of increases, thus a single .25-percent increase is not all we’re likely to see.

As always with the Fed it makes sense to see what it actually does – if it does anything – and then wait a few weeks to see how the market is really reacting.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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