Rising rates have made it increasingly difficult for Americans to check off major life milestones like purchasing a car, starting a business, and becoming homeowners. While the Fed has begun to implement smaller rate increases, they havent hit pause on rate hikes just yet.
Today, the Federal Open Market Committee (FOMC) announced the first interest rate increase of 2023a 25 basis point increase (the smallest increase since March 2022). Despite this being a smaller increase than past Fed increases and mortgage rates trending downward since November 2022, this move will likely usher in interest rate increases on several lending products, including credit cards, auto loans, and mortgageseven if only minimal ones.
And experts say it could be a little longer before the Fed pumps the brakes on rate increases altogether.
The Feds job is not done with inflation still running hot and wage pressures persisting, says Boyd Nash-Stacey, senior economist and head of Center of Excellence at Prevedere. This means we are likely to see two more 25 basis point increases in the federal funds rate, bringing the effective benchmark rate to around 5.1%.
How rates are determinedand where mortgage rates currently stand
Your mortgages interest rate is essentially the cost a lender charges you to borrow money to financed the purchase of a home. This rate is expressed as a percentage and can be fixed, meaning that its locked in and wont change throughout the life of your loan. Or, it can be a variable rate, which means that it can (and likely will) change in response to larger changes in the market and economy.
The Federal Reserve does not set mortgage ratestheyre set by individual lenders. However, the Fed does set one crucial rate: the federal funds rate. This rate can have impacts that trickle down to sway rates on consumer lending products like credit card APRs, savings account APYs, auto loan rates, and even mortgage rates.
The federal funds rate is an interest rate that banks charge other banks when they lend one another money, usually overnight or for a few days. Certain regulations require banks to keep a certain percentage of their customers money on reserve, and banks will lend money back and forth to maintain the right level.
When inflation is running high, the Fed will increase rates to increase the cost of borrowing and slow down the economy. When its too low, theyll lower rates to stimulate the economy and get things moving again.
Several factors influence mortgage rates. On a macro-level, mortgage rates tend to increase or decrease in response to the overall health of the economy, the inflation rate, the unemployment rate, and other key economic indicators. On a micro-level, rates will vary from lender to lender and your own financial stats. A mortgage is a loan, and your lender assumes a certain level of risk by loaning you that money depending on your income, credit score, employment situation, and debt.
Today, the average rate for a 30-year fixed-rate mortgage stands at 6.17%, while the average rate for a 15-year fixed-rate mortgage is 5.24%. Just a year ago, those rates stood at 3.73% and 3.01%, respectively.
What happens when the Fed increases or decreases interest rates
The FOMC evaluates various key economic indicators when deciding whether to raise or lower rates. One key signal is the inflation rate. According to the Fed, a 2% inflation rate is the sweet spot for maximum employment and price stability. In 2022, the Fed acted aggressively to tame rising inflation, boosting rates by 50-75 basis points seven times throughout the year.
Those interest rate increases prompted mortgage rates to rise steadily to pre-pandemic levels after hitting record-lows at the start of the pandemicbut rates have kept rising.
The continued drawdown in the Federal Reserves balance sheet, otherwise known as quantitative tightening, will increase the restrictiveness of financial conditions, limiting banks ability to lend and increasing the interest expense for new mortgages, says Nash-Stacey.
5 moves to make if youre preparing to buy a home right now
If youre planning on becoming a homeowner this year, youre at the mercy of the lenders who will decide whether or not to approve you for a mortgage. However, there are moves you can make to better position yourself to secure the best possible rateeven in an high-interest rate environment.
- Work on improving your credit score. The higher your credit score, the better chance you have of securing a mortgage with a more favorable rate. Be sure to pay bills, debt, and other monthly payments on time, consistently. If you havent checked your credit score in a while, you should aim to do so before embarking on the homebuying process. If your score is lower than you anticipated, request a free copy of your credit report from one of the three major credit reporting bureaus and comb through it to see if there are any factors or possible errors that could be dragging your score down.
- Shop around for the lowest rate. This may seem like a no-brainer, but take your time and compare rates from multiple mortgage lenders. Many offer free quotes online or by phone after youve answered a few key questions about your credit score range, loan amount, loan type and term. This is just an estimate and wont give you a completely accurate rate, but it will give you a ballpark idea of what kind of rate you may be able to secure from each lender. Once youve narrowed your list down, the lender you choose will thoroughly vet you and your financials during the preapproval process through a hard credit inquiry that will help them determine how much youre qualified to borrow.
- Save up for a larger down payment. Typically, a larger down payment will help you secure a lower interest rate. The larger your down payment, the less money you have to borrow overall, and the less youll pay in interest over time. Ideally, you should strive to have 20% of your homes purchase price set aside for a down payment, but for many homeowners, and especially first-time home buyers, this can be a stretch. After youve shopped around and taken a look at the rates various lenders are offering you, revisit your personal budget to determine how you might save a little extra for your down payment to reduce your overall borrowing costs and secure a lower rate. Even a fraction of a percentage point can translate to major savings over the life of your loan. You can also supercharge your savings and grow your down payment with the help of an interest-earning savings vehicle like a certificate of deposit or high-yield savings account.
- Think carefully about your loan term. Selecting a longer loan term can free up room in your budget to hit more immediate goals, but it will also come with a higher interest rate. If you have the room in your monthly budget to pay more each month, you might consider opting for a loan with a shorter repayment term to reduce how much you pay in interest over time and eliminate your debt a lot sooner.
- Be sure to lock in your rate. Mortgage rates are sensitive to a number of external factors, and as such you could benefit from a mortgage rate lock, also known as rate protection.This is offered by lenders (sometimes for an additional fee) to help you lock in the interest rate youre offered during the homebuying process to keep your interest rate from increasing between the time you apply for a mortgage and your closing date. Warning: even if your rate is locked, it can still change if there are changes in your applicationincluding your loan amount, credit score, or verified income.
The takeaway
The Feds latest interest rate increase will almost certainly impact rates on several consumer products. And while you may not be able to control the moves they make, you can help minimize some of the side effects on your home buying journey by improving your credit score, setting clear savings goals, and shopping around for the lowest mortgage rate.
