Refinance your mortgage before the Fed raises interest rates

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The window of opportunity is narrowing for homeowners who have not taken advantage of two years of historically low interest rates to refinance their mortgages.

Following the Federal Open Market Committee’s first policy meeting of the year, the Fed said in a statement that a rate hike would be appropriate “soon.” Markets expect this to mean the Fed will raise the fed funds rate at its next meeting in March. Such a move would put upward pressure on already rising mortgage rates.

The Fed does not set mortgage rates. It sets the federal funds rate, the short-term rate at which banks can borrow from each other. A rise in this rate increases lenders’ costs, which they pass on to mortgage borrowers in the form of higher mortgage rates.

“When the Fed is in a rate-raising environment, we tend to see all interest rates go up, including mortgage rates,” says Danielle Hale, chief economist at Realtor.com. A higher federal funds rate can also mean higher borrowing costs for student loans and personal loans, as well as higher payments in high-yield savings accounts.

For homeowners considering a mortgage refinance, Hale recommends acting as soon as possible, as she expects the general upward trend in rates to continue. “In this environment,” she says, “it doesn’t make sense to wait.”

Why are mortgage rates rising?

To be clear, mortgage rates are already on the rise as lenders, investors and economists all expect a change in Fed policy in the near future.

Mortgage rates have risen for four consecutive weeks, registering significant increases since the start of January. Current mortgage rates stand at 3.56%, an increase of 0.45 percentage points in the first three weeks of 2021. (Rates have increased by a total of 0.46 percentage points throughout 2021.)

Why is the Fed changing now? It has a lot to do with inflation, which hit a 40-year high of 7% in December. Simply put, labor and supply shortages drive up prices, making your dollar less valuable. The hope is that rising interest rates can slow this loss of value.

“It’s a big flip-flop,” Hale says, noting that as recently as November, a rate hike before the drop seemed unlikely. “You see this shift in sentiment spilling over into the interest rate environment.”

Refinance window is now smaller – but still open

Although rising rates have shrunk the pool of eligible applicants, they are still low enough for millions of homeowners to qualify for a refi.

There are currently 5.9 million well-qualified homeowners – those with at least 20% equity in their home and a credit score of at least 720 – who could reduce the current mortgage rate by at least 0, 75 percentage points by refinancing at current mortgage rates, according to mortgage data provider Black Knight. These homeowners could save an average of $275 per month on their current 30-year mortgage.

“We’ve seen the number of owners who could benefit from a refinance cut in half since the start of the year,” says Andy Walden, vice president of research and corporate strategy at Black Knight. “The clock is most certainly ticking.”

There may be additional savings available to homeowners considering switching from a 30-year loan to a 15-year loan.

The interest rate on a 15-year fixed-rate loan is nearly three-quarters of a percentage point lower than the 30-year rate (3.56% versus 2.79%). These homeowners may not see a reduction in their monthly payments, but it could save on long-term interest and reduce their total recovery time.

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And after?

What happens next to mortgage rates will depend on the impact of the initial Fed rate change on the economy. Most economists expect each increase in the fed funds rate to be 0.25 percentage points, which could indicate a more gradual increase in mortgage rates.

However, some economists believe the Fed could become more aggressive in trying to rein in inflation and could raise the rate by as much as 0.50 percentage points each time.

While any increase in the fed funds rate is likely to push rates higher, Hale doesn’t expect the rapid pace of increases we’ve seen in the first few weeks of 2022 to last, noting that rates could even see occasional declines throughout the year.

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