If you pay attention to financial news, you probably know that an interest rate increase was announced at the end of last year. Frequently, when interest rate hikes takes place, they create a ripple effect in various markets, leading to higher rates on everything from credit cards to personal loans. So, how will this recent announcement impact mortgage rates? It won’t, at least for most homeowners. Here’s why.
How Mortgages Work
A mortgage is a loan you take out from the bank or other financial institution in order to finance the purchase of a piece of property. These loans are typically for 30 years, although 15-year and even 10-year mortgage loans are not unheard of. There are also loans with longer terms, and some loans are indefinite, “interest-only” mortgages. With these loans, for example, the borrower only pays the accrued interest each month, leaving the principle balance unchanged.
As with any loan, a mortgage loan can be structured in a few different ways depending on your financial status and your ability to make payments. Some mortgage loans have adjustable interest rates—meaning the amount you pay for borrowing the money will change over time. However, after the housing crash of 2008, many borrowers shy away from adjustable rate mortgages and instead opt for fixed rate mortgages.
A fixed rate mortgage is a loan where the interest rate is fixed—or constant—for the life of the loan. A fixed rate loan will usually be slightly higher for the longer loans since the lending institution is exposed to slightly more risk on them; however, assuming that the property using the borrowed money is not overvalued, most mortgage loans are relatively low risk. If the borrower defaults the lender can simply foreclose the loan, seize the property, and sell it to pay off the loan.
Why Interest Rate Hikes Won’t Affect Your Mortgage
With this in mind, the issue of the recent interest rate hikes and how it impacts your mortgage comes to mind. The simple answer is this: because most mortgages are fixed rate mortgages, that means the interest rate you pay does not change regardless of what the market interest rate may be.
The market interest rate is directly affected by the federal interest rate—an increase of which was just announced. However, the prevailing rate at the time you took out the loan is the rate that controls how much you pay (assuming you have a fixed rate mortgage). As such, while the interest rate increase may mean slightly higher rates for new loans or adjustable rate mortgages—which derive their rate from a formula that includes the federal rate—rates for existing mortgages will not change.
While interest rate hikes are not ideal because of the resulting increase in the cost of obtaining credit, they are still a vital tool used to control inflation and stabilize economic growth. The good news is that, given that most mortgages are fixed rate mortgages, it should not have an appreciable impact on overall mortgage rates for existing loans. Was this article helpful in helping you understand interest rates and mortgages? Let me know in the comments below!