As most economic analysts expected, the Federal Reserve increased the Federal Funds rate from 1.25% to 1.50% while the Discount Rate quickly followed with a similar increase. But as we close out 2017 and head into 2018, what does that mean for the everyday consumer? Will higher rates slow down the economy? Will mortgages be more expensive, creating a housing slowdown?
One of the primary objectives of the Federal Reserve Board is to control the cost of money. While the Fed can’t do that directly, it can affect the cost of funds to individual banks which then in turn can lead to higher rates for borrowers. The theory is that when rates are higher, consumers tend to borrow less. When consumers borrow less they spend less. When there is less of a demand for consumer goods and services which is the result of less spending, prices for those goods and services remain suppressed. On the other hand, when the economy is building steam, consumers can feel more confident which can lead to more spending and more borrowing. And so the wheel turns.
Again, in theory, higher rates keep a lid on inflation. Something the Fed has actually been trying to move higher by keeping the cost of funds low. The target inflation rate has yet to hit that benchmark despite the Fed’s actions. So far in 2017 we’ve witnessed four such 0.25% moves and inflation is still below target.
The Federal Funds rate is the rate applied to short term borrowing when banks borrow from one another to meet reserve requirements. Today, the rate for this short term borrowing is 1.50%. This is the rate the Fed adjusted on the 13th of December.
But what the Fed doesn’t do is directly impact most mortgage rates. When consumers search for interest rates and have a fixed rate in mind, the Federal Fund rate has little to do with prevailing rates. Instead, conforming rates are tied to a specific mortgage bond. For a standard Fannie Mae 30 year fixed conforming rate, mortgage lenders price their rates each day based upon its appropriate bond. For this loan, the bond is listed as the FNMA 30yr and is bought and sold just like any other bond. And just like any other asset, the greater the demand, the higher the price. With a bond, investors know the return upon purchase. The price is set. When the price of a bond goes up the resulting yield must go down. And when demand for a bond goes down, the yield, or interest rate, goes up.
Investors alocate some of their funds toward bonds not to make a sizable return but to protect their assets from market fluctuations. When investors feel the economy is strengthening they tend to pull money out of bonds and into stocks, mutual funds or commodities. But again, the Fed has only a tangent role as it relates to fixed rate mortgages. On the other hand, for those with an adjustable rate mortgage, rates will be on the rise. Adjustable rate loans are those attached to consumer loans such as credit cards, home equity lines of credit, automobile loans and other consumer loans.
For those with an adjustable rate mortgage or home equity line of credit and the Prime Rate is the associated index, those monthly payments will be higher than they are today. For someone that has a fixed rate today, the Fed move has no impact. Analysts predict three more rate increases in 2018 due to continued economic growth. Unemployment rates have continued to fall and more and more people are back to work. The most recent statistics released by the Bureau of Labor reported the economy added another 228,000 jobs and the rate remained unchanged at 4.1 percent. This has been a consistent pattern over the past 12 months as the economy continues to add jobs as the unemployment rate falls.
So what does this all mean going forward? It means that if trends of gradual growth continue, rates should rise across the board. For those considering refinancing an existing mortgage or line of credit, money could very well be more expensive later than it is today. Home buyers must also be aware of the possibility of higher rates into 2018. If there in fact are three more rate increases in store for 2018, that means money will be 0.75% more expensive by this time next year.