How ARM, HELOC mortgage borrowers benefit from second Fed rate cut

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The Federal Reserve, responding to the economic turmoil from the coronavirus outbreak, cut interest rates to near-zero Sunday in a second emergency move in response to the cororavirus pandemic. This will mean lower borrowing costs for those who have adjustable-rate mortgages and home equity loans. 

“Lower rates provide an opportunity for lower-cost borrowing including for mortgages which support refinancing and prospective homebuyers,” says Mark Hamrick, Bankrate’s senior economic analyst. “For savers, it will remain important to shop around for the best rates.”

Although the three previous 25 basis point rate cuts in 2019 didn’t have a direct impact on fixed-rate mortgages, Fed actions do impact interest rates for borrowers with short- and variable-term loans, including credit cards and adjustable-rate mortgages (ARMs).

Here’s what rate cuts generally mean for homebuyers and homeowners.

What will happen to long-term fixed mortgages?

The federal funds rate does not directly affect long-term fixed-interest mortgage rates; those rates are pegged to the yield of U.S. Treasuries, which are set by market forces. Treasuries have been in a free fall lately. The rate on the 10-year, which is linked most closely to mortgage rates, has dropped to record lows during the pandemic.

Fixed-rate mortgages don’t move in lockstep with the Fed, but they’re not immune to Fed policy.

Variable-rate loans get cheaper when the Fed cuts

Variable-rate loans, such as ARMs and home equity lines of credit (HELOCs) track with the Fed funds rate, so those borrowers come out ahead when rates drop.

The cut in the federal funds rate by a full percentage point means a corresponding drop in variable rates, as well. Usually, borrowers will see a change in their loan statements the month after the Fed lowers rates.

To quantify this, on a HELOC of $100,000, every change of 0.50 percent in interest rate (either upwards or downwards) will cause a borrower’s interest expenses to rise or fall $500 per year. As this works out to about $42 per month, it should not have a big impact on most borrowers unless they have a very large HELOC, says Daniel Shlufman, mortgage banker at Classic Mortgage LLC.

Those with variable-rate mortgages might not see an immediate change to their bill from any rate cut. Such loans typically adjust annually on their anniversary dates. Some don’t adjust at all for the first two, three, five or even seven years.

What homeowners should do

Would-be homebuyers interested in a fixed-rate mortgage or those who want to refinance should take advantage of today’s low interest rates, experts say. There’s no way to time the market to get the best deal on rates, says Kan.

The best course of action for homebuyers is to decide whether they can afford the home they want based on their down payment and current mortgage rates. Today’s mortgage rates are low by historical standards, so waiting for even lower rates can mean missing an opportunity.

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