Fed finally hikes rates, but housing impact expected to be minimal

December 19th, 2016 6:19am
Interest rates are expected to rise even higher in 2017.

After much ado about the Fed's interest rate intentions, the central bank chose to raise its federal funds target range 0.25 percent last week. The flurry of pre-hike speculation and the subsequent reports on the potential impact of such an increase were wide-ranging in the days leading up to the Fed's December meeting, but cutting through the suspense was the fact that markets had already predicted and priced in a hike before the year's end. The result is that consumers, businesses and the national economy as a whole took higher rates in stride and don't expect any troubles to arise in 2017 in relation to more expensive loans.

The math behind higher rates
The Fed sets a standard target range for how much interest it will charge institutions it loans to, rather than benchmarking a specific percentage point. The current range rests between 0.50 - 0.75 percent, subtly higher than the previous 0.25 - 0.50 percent that persisted throughout 2016. Though the increase was technically substantial percentage-wise, in reality, the effect on loans and consumers is somewhat nominal.

That's because lending institutions create their own target ranges (typically 3 percentage points higher than the Fed's overnight interest rate) when doing business with other lenders, businesses or consumers. Instead of enforcing a strict hike across the board based on the Fed's latest movements, lenders still have leeway to charge customers how they see fit. Just because the Fed bumped its range by 0.25 percent doesn't mean every single mortgage in the U.S. is now charged 0.25 percent more interest each month, and likewise for business loans. Overall, the Fed's target range is really a practical benchmark and market signal to consumers and institutions on what is considered a safe, noninflationary metric of charging interest.

CBS MoneyWatch noted that December's rate increase was just the second hike in eight years and that rates are still historically low. Additionally, the most immediate impact of a rate hike is on short-term loans between banks themselves, not on longer-term options such as mortgages or student loans. Again, a 30-year adjustable-rate mortgage may not be affected all that much depending on the terms of the loan; however, holders of these "ARMs"​ will certainly be more impacted than conventional fixed-rate mortgage owners whose rates do not change with Fed movements. This is why analysts and advisors have recommended refinancing to fixed-rate options for many years now - it serves as insulation against potential rate hikes.

Based on the average American household's loan obligations, a rate hike of 0.25 percent translates to $401 a year in additional interest tacked onto principal balances, an effective rate of roughly $1 per day in extra costs.

Real estate to remain steady
The U.S. economy has proven strong enough to absorb rate hikes now and in the future. This is more promising than other nation's economies - Japan, Sweden and Denmark, for instance - which are viewed as growing too slowly to warrant rate hikes, according to Business Insider. In fact, each of these countries, and many others, have negative interest rates - a measure which is intended to induce further borrowing and spending, but as of late hasn't done much to pull economies out of slow-growth business environments. And their respective central banks don't have any inclination to raise rates if they may potentially harm markets even further by making loans harder and more expensive to obtain.

Contrasting this landscape to the U.S., the comparison is clear: The U.S. is poised for steady growth in the future, and as such, will likely incur additional rate hikes in the months and years ahead.

CBS MoneyWatch reported the Fed is primed to increase its target range three additional times in 2017 and several more times in 2018. This positive trendline correlates to how the central bank forecasts the nation's economy to perform in the future and that markets are strong enough to handle higher rates.

Housing in particular shouldn't see too many negative effects arising from higher rates.

Steve Udelson, president of online brokerage Owners.com, noted rate hikes aren't unexpected, according to CBS.

"We've been prepared for this for some time," said Udelson. "Gradual rate increases are unlikely to be a huge game changer."

Lawrence Yun, chief economist of the National Association of Realtors, stated the average 30-year home loan will be $10,541 more expensive when factoring in the Fed's most recent hike, which isn't negligible but also isn't astronomical when considering wage growth. Yes, buyers may now face higher real estate prices in 2017, but their incomes are projected to rise as well. Further, many savvy buyers already know this and are padding their savings in advance - money that could be used for down payments.

Home equity is also on the rise, CBS reported. This means fewer mortgages are underwater and that current homeowners have additional value built into their housing assets. This equity can be tapped into at any time to finance other purchases or to guard against lifestyle changes such as unemployment or disability expenses.

First-time and prospective buyers still have many things to their advantage next year, despite prices rising. For instance, they will have been in the market for longer, conducted more research and formed relationships with a greater number of potential lenders, agents and sellers. This sort of knowledge is invaluable regardless of future price climates. Concurrently, they will have greater access to market data which can help them find homes in other regions which may be more affordable.

Another factor to consider is that business growth is expected to continue for some time and federal tax rates may be reduced in short order during the incoming presidential administration. Sustainable growth juxtaposed with lower tax burdens means more job opportunities and higher take-home pay - financial advantages that any buyer is sure to benefit from.

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