What Do Higher Mortgage Rates Mean for Homebuyers?

Jun 24, 2022
In an effort to curb inflation and cool off an overheated economy, the Federal Reserve announced an interest rate increase by three-quarters of a percentage point on June 15. The latest of three rate hikes instituted by the Federal Reserve this year, the move represents the largest jump in interest rates since 1994. A major pivot from the historic near-zero rates set during the peak of the coronavirus pandemic, rising interest rates tend to have a significant impact on many potential homebuyers. Most notably, consumers will spend more money on new mortgages they take out to buy a home.

However, there are also important upsides to the central bank’s shift to a tighter monetary policy, even when it comes to navigating the housing market as a buyer. In fact, rate increases are often a sign of a healthier economy and can help create a more balanced market among buyers and sellers.  We’ve explored the major factors involved to provide a fuller picture of the dynamics of the current rate environment as it relates the housing market.

How the Fed’s increase in rates affects the cost of home loans

The Fed may adjust what’s referred to as its federal funds rate upward as a means to counter inflation and stabilize prices. Essentially, the federal funds rate refers to the interest rate that banks charge each other to borrow cash on an overnight basis in order to maintain the reserve balance required by law. The federal funds rate drives all interest rates. Importantly, banks and credit unions set their prime rates, which they extend to their most qualified applicants, based on this benchmark.

Generally speaking, the prime rate is the lowest interest rate that a financial institution will charge. Interest rates on products like adjustable-rate mortgages (ARMs) and home equity lines of credit (HELOCs) with adjustable rates are directly tied to the prime rate. The actual interest rate that the lender determines that a borrower is eligible to receive is set by taking the prime rate and adding a specific percentage point to it. 

If you have an adjustable-rate mortgage and the prime rate rises, you can expect to receive an increase in your payment at the next adjustment period. However, rate caps will apply to protect homeowners from exorbitant increases. On the other hand, fixed-rate mortgages don’t directly correspond to the prime rate benchmark but are instead strongly correlated to the yield on 10-year Treasury bonds. While a change in the fed funds rate has a less immediate effect on fixed-rate mortgages, rates on new loans will eventually rise as financial institutions must pay more to borrow money in order to manage cash flow. Of course, if you’ve already bought a home with a fixed-rate mortgage, your mortgage rate will remain the same.

The rate increase means some homebuyers may need to recalculate how much home they can afford to buy right now

When interest rates are higher, more of your monthly payment will be used to cover the interest on your loan each month. Therefore, you may have less money to budget for the house itself, and need to apply for a smaller loan in order to cover the principal amount, interest, taxes and insurance each month. At a higher interest rate, you’ll also spend more money over the life of the loan to own the home.

Fewer people who can afford to buy homes equals less competition and more opportunities for some buyers

In addition to reduced buying capacity, some homebuyers may find themselves priced out of the market by higher financing costs for the time being. But for those who can afford to remain, this can work toward their advantage. With fewer people vying for the same home, buyers stand a better chance of having their offers accepted, and may hold more leverage when it comes to negotiating terms. Furthermore, there may be more wiggle room when it comes to the home’s price if the seller is highly motivated and does not have multiple offers. 

Slowing demand may give inventory a chance to pick up

While experts aren’t projecting a dramatic increase in the number of available homes for sale in the U.S.  housing market to occur in the near term, it is not unforeseeable that the extremely low inventory which has been a hallmark of the housing market in recent years may begin to ease up as fewer buyers compete for homes. According to data from Realtor.com, the supply of homes for sale is already showing signs of improvement, which has been attributed to the over 2.5 percentage point increase on the average 30-year fixed mortgage since the beginning of 2022. Although an increase in inventory levels is likely to be gradual, the statistics do suggest the possibility of a more balanced picture on the horizon.

Rising interest rates may lead to decelerating price growth

Another common feature of rising interest rates is the slowing of home price growth. With more people exiting the housing market as monthly payments become less affordable, reduced demand can cause home prices to increase in value at a less accelerated pace. While real estate generally appreciates in value over time, home values don’t tend to increase as fast in periods of rising interest rates. As reported by the Mercury News, economists from the California Association of Realtors (CAR) project slower price growth in the San Francisco Bay Area over the second half of 2022. However, experts are also quick to point out that a drop in demand has yet to occur, with potential buyers scrambling to lock in rates that are still quite reasonable from a historic perspective.

Interest rates will continually fluctuate as the central bank works to safeguard the value of the U.S. dollar and fight inflation while promoting full employment and growth in production. As financial experts point out, trying to time the market to buy a home when interest rates are at record-lows is not necessarily advisable from a big-picture perspective of your finances. In many cases, this may not even be feasible since interest rates tend to decrease when a high number of people are unemployed or when wage growth is sluggish.

Buying a home is a rewarding life goal that allows you to build a wealth and financial security through equity in your home and appreciation in value over time. In addition, a home you buy to live in today might eventually serve as a potential investment property that can be used to grow a real estate portfolio and generate cash flow down the road. For most prospective homeowners, the best strategy is to buy a home when you can afford to, and when it makes the most sense based on your lifestyle and priorities. If necessary, you can decide to refinance at a later time.

When you’re ready to explore the possibility of home ownership, our lending team can help discuss the best course of action for you. To help our members get the financing they need now, The Police Credit Union provides a wide variety of solutions to suit different budgets and goals. Our mortgage products feature low fees, a competitive APR and low down payment options.

In addition, we’re proud to offer our signature H.E.R.O. (Helping Enable Residential Ownership) Mortgage Loan with 100% financing for first-time homebuyers. Available exclusively to our active law enforcement members, this 0% down payment option features no PMI (Private Mortgage Insurance) requirements, loan limits up to $1,000,000* and a quick approval. Find details and apply here.

Program available to first-time homebuying members of the credit union that are an active full-time sworn peace officer or reserve peace officer employed by a federal, state, county or municipal agency. Program consists of a fixed or variable rate 1st and a fixed 2nd mortgage. Property must be located in California, and be owner occupied. First time home buyers may not have had ownership in a principal residence during the preceding 3 years. All loans subject to credit approval, documented income and reserve requirements. There is a non-refundable application fee of $95 for this program that will be credited back at closing. Additional terms, conditions and restrictions apply. Program is subject to change or cancellation without notice. Contact your TPCU Loan Officer for terms, rates and full details. Federally insured by the  NCUA. Equal Housing Opportunity. NMLS #: 409710

*Maximum loan limit may go up to $2,000,000 for qualified applicants, amount is for the total combined amount of the first and second mortgages.

Providing Financial Solutions to Take Care of Our Own

  • Accessibility
  • Federally insured by the National Credit Union Administration
  • Equal Housing Opportunity
  • NMLS ID# 409710

APR = "Annual Percentage Rate". Actual APR is based on your credit profile and may be higher than the lowest rate available. Posted rates may include promotional discounts and other terms and conditions. APY = "Annual Percentage Yield". Rates are subject to change without notice.

The Police Credit Union proudly provides banking and loan solutions including checking accounts, credit cards, auto loans and more for police and other law enforcement agencies and their families  in the Bay Area and beyond. Visit us at one of our branches in San Francisco, Pleasanton, San Mateo, San Bruno or Oakland, CA or check if you are eligible for membership and apply online today.

Site Design by ZAG Interactive. © 2019 The Police Credit Union.