You are an American homeowner, which means you have one of the most important pillars for securing the American Dream. However, now that you own property, you might be more concerned than usual with the economy. After all, homeowners across the country suffered a major hit when the housing bubble burst in 2008 — and you don’t want the same thing to happen to you in this day and age.
Thus, recent news of the Federal Reserve meddling with interest rates might have you shook. At first, they raised interest rates; now they are refusing to do so again. Is this normal? How does this affect home values? Should you sell your house and go back to renting before the economy collapses again?
The truth is that the Fed has always had a hand on interest rates — but despite what President Trump and other politicians might think, this isn’t a bad thing. Read on to learn what the Fed really does and how that might (or might not) affect the housing market.
First Thing’s First: The Fed Doesn’t Set Mortgage Rates
Repeat this mantra every time you see a bit of news about the Fed: The Fed doesn’t set mortgage rates. Rather, the Fed determines the federal funds rate, which impacts short-term and variable (also known as adjustable) interest rates, as opposed to your mortgage, which is a long-term, ideally fixed loan.
Specifically, the federal funds rate impacts how banks and other financial institutions lend money to one another. This is a common occurrence, used to manage liquidity of assets and meet mandated reserve levels, i.e. the amount of cash banks must have on hand. Thus, when the Fed raises the federal funds rate, it becomes more expensive for banks to borrow from one another, and those higher costs can be passed onto consumers in the form of higher interest rates for lines of credit, auto loans and — you guessed it — mortgages.
Still, mortgage rates are determined by a number of factors, not just the federal funds rate, and home prices themselves are dependent on a similarly complex system. While a small change in a mortgage interest rate could alter monthly payments by a few tens of dollars, it shouldn’t drive any homeowner out of their property and back into rentals. Meanwhile, those hopeful to purchase a property in the coming months might want to move quickly to get preapproved — and they should be sure to opt for a fixed-rate mortgage, which won’t be impacted by the Fed at all after the contract is signed.
The Fed Raising Rates Is Actually a Good Sign
While higher interest rates might seem like a disaster for consumers, it really, truly isn’t. Here are just five good things that happen when interest rates rise:
Tamed inflation. Inflation happens whenever the economy performs well, but it is disastrous for consumers. The Fed raises rates largely to keep inflation in check, so your dollars don’t become worthless in a matter of months. In fact, increased rates should make the dollar stronger, making the exchange to different currencies more favorable.
More lending. Lending is good for the economy, and it is good for the average person, too. Banks feel pressured to lend money to consumers instead of keeping it locked tight within financial institutions. Thus, you can acquire favorable home equity loan rates in NJ (or wherever) and prosper.
Higher returns for savers. The bank uses the money you place in your savings account, and for that trouble, it provides you a modest increase in savings through interest. When interest rates rise, your savings account could do more work for you, which means you might want to start shopping for the best rates.
Higher income for retirees. The money you put in your retirement account is supposed to grow as you age. When interest rates increase, that money will grow at a faster pace, meaning you’ll get more bang for your buck and have greater wealth when you retire to Aruba (or wherever).
Renewed focus on market fundamentals. If you don’t know much about the stock market, this might not seem like a benefit, but because rates are returning to normal levels, stock prices will likely begin to make more sense. Since the recession, investors have been forced to focus heavily on the Fed’s monetary policy, but now that rates are “normalized,” market fundamentals should take center stage, as they should.
If you don’t understand the nuances of the economic landscape, news about “raising rates” can sound scary. However, by learning what you can about what this behavior means, you won’t make any rash decisions that will hurt your financial future — and you can stay in your comfortable house without worry.