Why Are Mortgage Rates Going Up?

Key Takeaways

  • Mortgage rates have increased dramatically, with the average 30 year fixed rate increasing from around 3% at the start of 2022 to around 7% now.
  • This is down to the Fed’s policy of increasing interest rates in a bid to slow the economy and, most importantly, slow the rate of record high inflation.
  • Would-be homeowners are facing monthly mortgage repayments hundreds of dollars higher than just a few months ago, which is likely to mean purchase timelines are pushed back.
  • For some, investing is one way to help make up the difference over the coming years.

By now you’ve probably seen that interest rates are on their way up. The Fed has been raising rates for a number of quarters now in an attempt to wind down the sky high levels of inflation. So far they’ve not had much luck on that front, but there’s one major area that has been heavily impacted.

Mortgages.

The rate of the average mortgage has gone through the roof in recent months, which is making it even harder for first time buyers to get on the property ladder.

At the start of 2022 the average 30 year mortgage rate was around 3%. Mortgage rates have been low for a while now, but at the start of the year they began to creep up. Now, average mortgage rates have risen to over 7%.

That’s a huge difference.

A few percentage points may not sound like a lot, but they really add up when you’re talking about a mortgage of a few hundred thousand dollars. For example, on a mortgage of $300,000 the increase from 3% to 7% would mean the average monthly payment has increased from $1,265 up to $1,996.

That’s an extra $731 per month, on top of the already rocketing prices of everything else. It’s no wonder that potential new home owners are having second thoughts on whether they can afford to buy.

But how does the Fed increasing interest rates impact what a homeowner pays for a mortgage? Let’s look into it.

Download Q.ai today for access to AI-powered investment strategies. When you deposit $100, we’ll add an additional $100 to your account.

How higher Fed rates increase mortgages

Essentially any type of loan is based on the base rate set by the Fed. It’s called the base rate because it’s the rate on which all other interest rates are ‘based’. In practical terms, the Fed’s rate is what the banks themselves pay in interest for short term borrowing.

Short term borrowing is a fundamental part of the financial system, with money flowing around so fast that it can’t all be accounted for and transferred instantly.

Because of that, the more interest that they themselves pay, the higher interest they need to charge to their customers to maintain their profit margins. If the Fed raises rates, banks pay more interest and they therefore need to increase the interest they charge to their customers.

If the Fed reduces interest rates, the banks pay less interest which means they can reduce the interest they charge to their customers.

These interest rates flow through to any form of debt you can think of. Mortgages and auto loans are probably the biggest ones, but there’s also credit cards, unsecured personal loans, bank overdrafts, student loans and business loans.

Even things like late payment interest on bills can be linked to the base interest rate.

What this means is that when the Fed moves rates, it impacts the financial position of many people in many different ways.

When it comes to mortgages, the most common type of loan in the US are long term fixed rates. That means that homeowners who locked in a 30 year loan last year are going to be paying the same rate of interest for the full term of their loan. Because of this, they don’t need to worry about rates going up, because their mortgage is a fixed rate.

The problem comes when first time buyers want to get into the market, or when existing homeowners want to move and/or refinance. When this happens, they’ve got to go back to the open market to get their loan, which is now going to cost them a lot more money.

Why are mortgage rates going up?

So to summarize, mortgage rates are going up because the Fed has been raising the base interest rate. A higher base rate means banks pay more in interest, which they then need to pass on to their customers to maintain their margins.

Why is the Fed raising interest rates?

That leads us on to another question. If raising rates makes mortgages and other types of debt more expensive, why are the Fed doing that? Especially at a time when households are suffering with cost of living increasing across the board.

Well, that’s exactly why they’re doing it, because the cost of living is increasing so much.

The whole point of raising interest rates is to slow down the economy. By making mortgages, car loans and credit card debt more expensive, it means people have less money in their pockets to spend on other things.

With less money to spend on restaurants, holidays, new clothes and video games, company revenues fall. With lower revenues comes less spending, fewer wage increases and a general slowdown of the economy.

The end result of all this is that prices stop rising, or at least stop rising as fast, which means inflation slows. That is the number one aim of the Fed right now, to get inflation back down to normal levels.

The problem is that usually inflation is high because the economy is booming. People are getting huge pay rises, spending lots of cash and generally just having a banging old time. This time, inflation is high not simply because of a booming economy, but because of the general logistical weirdness that has been created off the back of the pandemic.

The Fed is in a tough spot. Either do nothing and potentially see inflation continue to run rampant, or raise rates and make life more difficult for people in the short term, with the hope that it improves things in the long run.

They’re taking the second option.

What can priced-out first time buyers do?

Many potential homeowners are likely to have seen their purchase timeline blow out. With mortgages becoming a lot more expensive, more people will need to wait for rates to come back down, or save up a larger down payment.

It might take a long time for rates to get back to where they have been and seeing as we’ve gone through the lowest interest rate period in history, they may never be so low again.

For many, this means that getting together a larger down payment is going to be the only way forward. The question is, where do you invest right now if the economy is under pressure from the Fed’s rate hike policy?

Firstly, would-be investors should keep in mind that investing is a long term game. You probably shouldn’t consider traditional stock market investments if you have less than three years until you want to access your cash, and a five year timeframe is preferable.

If you fit the bill, our Large Cap Kit is a solid option to consider. During periods of slow economic growth, big businesses tend to outperform smaller ones. They tend to have more stable and diversified sources of revenue and don’t rely as heavily on new customers to maintain their business.

To take advantage of this, the Large Cap Kit uses a long/short approach to go long on large caps while at the same time going short on mid-sized and small caps.

This means that investors generate profits off the relative change between the two groups, rather than the outright performance. It means that even if the overall stock market is sideways, or even down, investors can make money as long as big companies hold up better than small ones.

This kind of sophisticated pair trade is usually reserved for the high net worth players on Wall Street, but we’ve made it available for everyone.

Download Q.ai today for access to AI-powered investment strategies. When you deposit $100, we’ll add an additional $100 to your account.

Source: https://www.forbes.com/sites/qai/2022/10/31/why-are-mortgage-rates-going-up/