So, when the Fed raises rates this time, who will be hurt the worst?
First things first: the Fed controls the overnight cost of money, the “Fed funds” rate, not mortgage rates. Only twice in the Fed’s history has it directly influenced long-term rates: WWII to the Korean war, and during Quantitative Easing (QE) from 2009 to 2014.
Long-term rates — like mortgages — are set by markets and often behave perversely. As now. Short-term Treasurys and indices like Libor are rising, but not mortgage rates.
Until — if — mortgage rates rise, nobody is hurt except existing ARM (adjustable-rate mortgages) and home equity borrowers, and those who are thinking of taking out a new ARM while the Fed is tightening (not a great idea).
[Tweet “Until mortgage rates rise, nobody is hurt except existing ARM and home equity borrowers.”]
Long-term rates rise when the Fed is tightening if markets think the Fed has a long way to go. In 1994, the Fed hiked from 3.00 percent to 6.00 percent in less than a year, and mortgages ran up from 6.75 percent to 9.75 percent. This time the Fed is likely to be much more gradual, hiking slowly over several years.
Long-term rates also jump when the bond market thinks the Fed is “behind the curve” — too slow to tighten and giving inflation a running start. Not now — if anything, the dominant bond market opinion holds that the Fed is taking significant risk by tightening at all.
Back to “who’s hurt” if rates do actually jump. A 1-percentage-point rise in rate equals a 7.5 percent increase in the principal and interest payment. Peanuts. If $1,000 before, $1,075 afterward.
Consumers will feel it, but the psychological harm going from 4-something to 5-something is always greater than the payment shock itself.
Some say first-time buyers will be hurt worst. Based on the parade of clients we see in the real world, the choke point for first-timers is not the mortgage payment.
It’s these two things: First, young people have a very hard time accumulating a down payment. They are laden with student loans and health insurance expenses, and even if they save, their savings don’t earn anything.
[Tweet “Young people have a very hard time accumulating a down payment.”]
Second, income instability is more troublesome to the youth set than income altitude. Youth face sudden switches to contract employment from salary, or from high-base to high-incentive — both mortgage killers.
Last things last. Mortgage rates are not going to run up unless and until inflation does, and this Fed tightening is entirely pre-emptive of inflation not on any radar.
“Who is hurt?” If the Fed overdoes its tightening, everyone gets hurt by an unnecessarily weakened economy.
Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.
