Why Mortgages Will Become More Costly After Latest Fed Rate Hike

coldsnowstorm / iStock.com
coldsnowstorm / iStock.com

The latest 0.25% interest rate hike on Feb. 1 by the Fed means more borrowing cost increases on everything from auto loans to credit card payments. While Fed rate raises don’t correspond exactly with mortgage rate increases, relief for potential homebuyers might not come as quickly in 2023 as they would like.

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Amid persistent high inflation, the Central Bank raised rates at an unprecedented pace in 2022. However, the latest quarter-point increase was expected as “Inflation has eased somewhat but remains elevated,” the Fed stated. No matter the final number, another Fed rate hike will likely push mortgage rates even higher than they already are.

In November, the average interest rate on a 30-year home loan reached 7% for the first time since 2002, the New York Times reported. That’s up from 3.14% as recently as a year prior. According to LendingTree, 2023 mortgage rates should continue to trend lower, but could stay at their current levels for the majority of 2023, according to Jacob Channel, senior economist for LendingTree.

Another Fed rate hike doesn’t necessarily mean mortgage rates will see a significant spike, Channel told CBS News in an email. “Remember that while the Fed’s actions do impact mortgage rates, it doesn’t directly set them,” he said.

But as NextAdvisor noted, whenever the Fed raises interest rates, banks typically raise rates on mortgage loans, home equity loans, lines of credit and other products.

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Home equity loan rates are determined by the cost to banks and other lenders of borrowing money, which means those rates will likely go up following the Fed’s rate hike. That’s even more likely with home equity lines of credit (HELOCs) because their variable rates are often based on an index that mirrors the Federal Reserve.

A blog on the Experian website noted that when the Fed hikes interest rates, it means the central bank is changing its target for the federal funds rate. That’s the rate the Federal Open Market Committee (FOMC) advises commercial banks to charge when they lend money to other banks.

Banks typically add 3% on top of the federal funds rate when setting their prime rate for customers, Experian explained. This means homebuyers can usually expect to see higher mortgage rates whenever the Fed implements another rate hike. It also means many lenders will make it even more difficult for some buyers to get a loan.

This is a problem for all homebuyers, but even more so for minorities, who already have a higher-than-average denial rate on mortgage applications. For all applicants in the United States, the purchase application denial rate was 8.3% in 2021, National Mortgage News reported. In contrast, the denial rate for Black potential homebuyers was 15.3%, and the denial rate for Hispanic whites was 10.6%.

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“The higher the interest rate, the greater impact on homeownership for minority households,” Daniel Smith, Founder and CEO of homeowner platform Keepingly, said in an email comment to GOBankingRates. “Current rates make the monthly cost more expensive for these borrowers, effectively squeezing them out of the market.”

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