The Federal Reserve raised interest rates to a range of 3% to 3.25% in mid-September, continuing a trend of interest rate hikes which has not been seen since the mid-1990s. This move was an attempt to curb the rapidly increasing rate of inflation, reducing the demand portion of supply-and-demand. The interest rate hike will have tangible ramifications for homeowners and home buyers, but what does it all mean? Merino & Associates has put together a quick guide to some of the ways you may be affected by the rate hike.

Photograph of a lender describing loan terms to potential home buyers.

What is a Federal Reserve Interest Rate?

A Federal Reserve interest rate is the percentage that a bank must charge another institution when lending that institution a portion of its excess reserve funds. Reserve funds are the funds that banks are legally required to keep in an account at the Federal Reserve bank so that it can always accommodate the withdrawals of its depositors. Raising or lowering this interest rate makes borrowing money more expensive, making it less attractive to buyers looking to make moves like buy a car or make other transactions that involve opening a large loan.

What Does It Mean for Home Buyers?

Over the past couple years, there has been a huge demand for homes due to low interest rates, and there has been a huge potential for profit on the part of sellers who may have found the value of their homes had increased dramatically. With the increase in interest rates, we may see a decrease in demand, and the extremely competitive home buying market may begin to settle down once again. The downside is that since home loans will become more expensive, some buyers may have to adjust their expectations on their desired home to account for the extra added cost.

What Does It Mean for Sellers?

The biggest ramification that interest rate hikes can have on the market is the fact that a portion of buyers will no longer be participating in the market as they readjust their expectations or prepare for another period of low rates. That said, it does not mean that it will be impossible to sell a home. At the end of the day, when someone needs to move, they must find a home regardless of the current federal interest rate. It may take more time to sell than it had in the past couple years, but by setting healthy expectations and staying prepared, you can ensure your home sells as quickly as possible.

Is It Dangerous to Buy a Home When Interest Rates Are High?

The biggest downside to buying a home when interest rates are high is that keeping a high interest rate will lead to you spending more to pay off your mortgage than you would if interest rates were low. The good news is that you may not necessarily be locked into that interest rate for the next 30 years. There are two types of mortgages someone can take on when buying a home: fixed-rate or adjustable-rate. Buying a home with an adjustable-rate mortgage means that your interest rate can change depending on the state of the market at the time. The upside is that if interest rates decrease, so too with your monthly payment. The downside is that the same is true in the converse: as interest rates increase, so too will your payments. Your financial advisor will look at many factors beyond the current interest rate, such as the 10-year Treasury Bond yield, to determine what type of mortgage may be the best option for you.