Why are mortgage rates rising? -Forbes | CarTailz

The central theses

  • Mortgage rates have risen dramatically, with the average 30-year fixed rate rising from about 3% in early 2022 to about 7% now.
  • This is due to the Fed’s policy of raising interest rates to slow the economy and most importantly curb record high inflation.
  • Would-be homeowners are facing monthly mortgage payments that are hundreds of dollars higher than they were just a few months ago, which will likely mean purchase dates are pushed back.
  • For some, investing is a way to make up the difference for years to come.

By now you’ve probably seen that interest rates are on the way up. The Fed has been raising interest rates for several quarters to bring down sky-high inflation rates. So far they haven’t had much luck on that front, but there’s a big area that’s been badly affected.

mortgages.

The interest rate on the average mortgage has gone through the roof in recent months, making it even harder for first-time buyers to climb the real estate ladder.

At the beginning of 2022, the average 30-year mortgage rate was around 3%. Mortgage rates have been low for some time, but they slowly started to rise earlier this year. Average mortgage rates have now risen to over 7%.

That’s a huge difference.

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

That’s an additional $731 per month on top of the already skyrocketing prices for everything else. It’s no wonder prospective new homeowners are considering whether they can afford to buy it.

But how are the Fed’s rising interest rates affecting what a homeowner pays for a mortgage? Let’s take a look.

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How higher Fed rates increase mortgages

Basically, 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 interest rate is what the banks themselves pay in interest on short-term loans.

Short-term credit is a fundamental part of the financial system because money moves so quickly that it cannot be booked and transferred immediately.

So the more interest they pay themselves, the more interest they have to charge their customers to maintain their profit margins. When the Fed raises interest rates, banks pay more interest and therefore have to increase the interest rates they charge their customers.

When the Fed cuts interest rates, banks pay less interest, which means they can reduce the interest they charge their customers.

These interest rates feed into every form of debt you can think of. Mortgages and auto loans are probably the largest, but there are also credit cards, unsecured personal loans, bank overdrafts, student loans, and business loans.

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

This means that when the Fed changes interest rates, it affects many people’s finances in many different ways.

When it comes to mortgages, long-term fixed-rate loans are the most common type of loan in the United States. That means homeowners who took out a 30-year loan last year will pay the same interest rate for the life of their loan. Because of this, they don’t have to worry about rising interest rates since their mortgage is a fixed rate mortgage.

The problem arises when first-time buyers want to enter the market or when existing homeowners want to relocate and/or refinance. If that happens, they’ll have to go back to the open market to get their loan, which will now cost them a lot more money.

Why are mortgage rates rising?

In summary, mortgage rates are rising because the Fed has raised interest rates. A higher policy rate means banks pay more interest, which they then have to pass on to their customers to maintain their margins.

Why is the Fed raising interest rates?

That leads us to another question. If rate hikes make mortgages and other debt more expensive, why is the Fed doing it? Especially at a time when households are suffering from a general increase in the cost of living.

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

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

With less money to spend on restaurants, vacations, new clothes, and video games, business revenue falls. With lower earnings comes lower spending, fewer wage increases, and an overall slowdown in the economy.

The bottom line of all this is that prices aren’t going up anymore, or at least aren’t going up as fast, which means inflation is slowing down. That’s the Fed’s number one goal right now, bringing inflation back to normal levels.

The problem is that inflation is usually high because the economy is booming. People get huge raises, spend big, and generally just have a hell of a time. This time, inflation is high not only because of a booming economy, but also because of the general logistical madness that has sprung up in the wake of the pandemic.

The Fed is in a difficult position. Either do nothing and possibly let inflation continue, or raise interest rates and make life harder for people in the short term in hopes that this will improve things in the long term.

You choose the second option.

What can budget first-time buyers do?

Many prospective homeowners have likely seen their buying schedule fall through. As mortgages become more expensive, more people have to wait until interest rates come down again or save up a larger down payment.

It could be a long time before interest rates get back to where they were before, and since we’ve been through the lowest rate period in history, they may never be that low again.

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

First, potential investors should remember that investing is a long-term game. You probably shouldn’t consider traditional stock market investing if you have less than three years before you want to access your money, and a five-year time frame is preferable.

If you fit the bill, our Large Cap Kit is a solid option to consider. In times of slow economic growth, large companies tend to outperform smaller ones. They typically have more stable and diversified revenue streams and don’t rely as heavily on new customers to sustain their business.

To capitalize on this, the large cap kit uses a long/short approach to go long large caps while simultaneously short mid-size and small caps.

This means that investors are making gains from the relative change between the two groups, rather than overall performance. That means investors can still make money even when the stock market as a whole is flat or even down, as long as large companies fare better than small ones.

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