Your Guide To The Federal Reserve & Mortgages
12/23/2020 Corinne Browne
On December 16, 2020, the U.S. Federal Reserve announced that its benchmark interest rate would continue to stay at the historically low range of 0.00% to 0.25%, where it has been held since the board’s initial groundbreaking decision on March 15, 2020, in reaction to the onslaught of the coronavirus pandemic and its grip on economies worldwide.*
But what does this mean for you and your monthly mortgage payment? Let’s find out.
Why does the Federal Reserve lower interest rates?
The Federal Reserve System (The Fed) is the central bank of the United States, which regulates financial institutions. In response to timely economic conditions, the Fed decreases the benchmark interest rate (the base rate financial institutions use when lending) to encourage borrowing and lending among banks, businesses and consumers.
The Fed’s rate changes have a broad impact on the economy, which eventually lead to a general decrease or increase in interest rates over time, particularly for new credit.
What causes the Fed’s rate decisions?
There can be several factors or national economic events that come into play, but essentially the main influences on the Fed’s decisions are the employment rate, inflation and any resulting projections about the long-term health of the economy. While one can always try to make an educated guess, the one standard we can rely on is that we never know what the Fed is going to decide is best for the economy at any given time and how rates may fluctuate as a result.
Should I refinance right now?
When the federal lending rate decreases, your monthly payment could temporarily decrease if you have a HELOC, ARM, or another variable-rate loan, and your variable loan has reached beyond its initial fixed introductory period. Conversely in these cases, when rates start climbing again, your payments could increase.
If you have a fixed-rate mortgage, your rate stays the same for the life of your loan, regardless of the length of your term (e.g., 15 or 30 years) or fluctuations in the federal lending rate.
Whether you have a fixed-rate or variable mortgage right now, it’s important to understand that 30-year fixed mortgage rates are at historic lows. Consider refinancing if any of the following factors apply to you:
- Current mortgage rates are at least 0.5% lower than your current fixed rate.
- You have a variable or adjustable-rate mortgage, you’re planning on staying in your house for several years, and you’d like to lock in a lower-interest fixed-rate loan.
- You’d like to shorten the life of your loan — for example, move from a 30-year fixed mortgage into a 15-year fixed rate mortgage.
- Your home value has risen, and current, low interest rates could help you draw responsibly on equity with cash-out refinancing.
- Your refinanced interest rate is much lower than your interest rate on credit cards or other debt. Cash-out refinancing can be used to pay off multiple debts, as part of a balanced financial plan.
How do falling interest rates impact my monthly mortgage payment?
Lower mortgage interest rates make owning a home less expensive by reducing your monthly payment, which, in most cases, is composed of principal, interest, taxes and insurance. You’ll also save money over the life of your loan.
For example, if you have a 30-year fixed loan of $100,000 with 6% interest, you’ll pay around $600 a month. If refinancing lowers your rate to 3%, you would pay around $422 a month — that’s an extra $178 in your pocket every month (or $2,136 per year) that could go toward other things you want to spend your hard-earned cash on.**
Rates also influence how much house you can buy. Decreasing interest rates can make that new home you’ve been pining after (the one just outside of your price range) suddenly affordable. The inverse is true, too — what you could afford at a 3% interest rate may become impossible at 6%. But luckily for current homebuyers, today’s low rates have allowed for many to take advantage of the resulting increase in buying power and opt for a much-needed larger space, particularly with the prevailing rise in homeschooling and working from home.
How high or low can mortgage interest rates go?
To give further perspective into just how low current rates stand, looking back to 1981 when the average cost of a home in the U.S. was just $82,000, mortgage rates skyrocketed as high as 18.45% while the Fed attempted to slow down rampant inflation. In contrast, in 2012 when the U.S. economy was struggling to recover from the Great Recession, rates had dropped to 3.35%, an astounding low at the time.***
These days, since the Fed lowered the benchmark rate in March 2020, mortgage rates have been consistently hitting dramatic and historic lows. The average 30-year fixed-rate mortgage on October 22, 2020 dropped to a record-breaking 2.80%, as shown on Freddie Mac’s 2020 Primary Mortgage Market Survey.****
With interest rates so low, you might want to start thinking about how you can take advantage of the special savings available should you decide to sell your home, buy a new one, or refinance your existing mortgage. To learn more about your options, get started online, or connect with a PennyMac Loan Officer today.
By refinancing your existing loan, your total finance charges may be higher over the life of the loan.