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What Do Higher Mortgage Rates Mean for My Home Loan?

·3 min read

Inflation and interest rates are becoming the topic of conversations at kitchen tables across the United States. The Federal Reserve has already raised interest rates a total of 150 basis points since the start of the year. Borrowers are already seeing the impact of that on the interest rates they pay on unsecured debt. It’s also evident in rising mortgage rates. From rates below 3% in 2021, the average rate on a 30-year fixed-rate mortgage is now over 5%.

Many current and prospective homeowners are wondering what impact these rising mortgage rates will have on their home loans. The simple fact is that the cost of financing a home is going up. But the type of mortgage you have will determine how much rising mortgage rates will affect your home loan.

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Fixed-Rate Mortgages Provide Cost Certainty 

If you already own a home with a fixed-rate mortgage or have a signed contract that locked in a fixed rate, you can breathe easy. Your rates will not be changing. That’s the benefit of a fixed-rate mortgage. When faced with inflation pressures and rising interest rates, homeowners have the cost certainty that their mortgage will not increase. 

The Perils of Adjustable-Rate Mortgages 

If you have an adjustable-rate mortgage (ARM), you may not be as lucky. When interest rates are increasing, adjustable-rate mortgages will move higher. This will increase the amount of money that borrowers pay on their mortgage. In fact, it was this resetting of interest rates during the financial crisis that forced many homes into foreclosure or short sales.  

However, all hope is not lost. First, adjustable-rate mortgages come with a cap. This means there is a limit as to how high interest rates (and by extension payments) can go over the lifetime of the mortgage. Therefore, if borrowers have the financial wherewithal, they may choose to ride out the current interest rate environment and hope that rates will stabilize or even reverse at some point.

Alternatively, unlike the interest rates on credit cards, auto loans and personal loans it can take ARMs a little time to reset. This is typically done either annually or semi-annually. This means, depending on their particular schedule, qualified homeowners may have time to refinance their mortgage into a fixed-rate mortgage to gain cost certainty.

It Only Feels Like the 1980s for Mortgage Rates

According to Nerd Wallet, as of June 2, 2022, the average mortgage rate on a 30-year fixed mortgage is 5.236%. For a 15-year fixed-rate mortgage, the rate is 4.437%. and for a 5-year adjustable-rate mortgage (ARM), the rate is 4.184%. 

Millennials have not yet experienced inflation at these levels. And for many of younger millennials, mortgage rates above 5% are higher than they remember in their lifetime. But from a historical perspective, mortgage rates are only now approaching the 50-year average (records weren’t kept by Freddie Mac until around 1971).  

In fact, in 1981, the average rate on a 30-year fixed-rate mortgage was over 16.6%. And keep in mind, this is a rate that was available for borrowers with impeccable credit and a sizable down payment.  

However, comparisons like this need to be counterbalanced by the reality that our society is much different than it was in the early 1980s. It is far more credit and consumption driven. And student loans are a part of millennial budgets in ways that older generations did not have.  

On the date of publication, Chris Markoch did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

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