The Fed keeps rates near zero, helping ARM, HELOC mortgage borrowers

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The Federal Reserve left its benchmark interest rate near zero at its regularly scheduled FOMC meeting today. As the central bank of the United States, the Federal Reserve has become one of the main players in combating the economic slings and arrows of the coronavirus pandemic, including helping the mortgage industry. The Fed lowered the fed funds rate from a target range of 1 to 1.25 percent to 0 to .25 percent on March 15 to help a sinking economy.

Although the fed funds rate doesn’t impact mortgage rates directly it does have an effect on adjustable-rate mortgages (ARMs) and home equity lines of credit (HELOCs). So keeping the rate to this all-time low helps ARM and HELOC borrowers save money. 

Currently, interest rates for a 5/1 ARM are hovering around 3.56 percent, according to Bankrate’s national survey of lenders.

The Fed will also continue to inject billions of dollars in the bond market, in order to keep the mortgage industry’s wheels greased. This is important for borrowers as rates have sunk to record lows, giving them a chance to refinance their existing mortgage. The Fed’s role in keeping the market afloat helps both lenders and borrowers.

 “The Fed pledges to buy Treasuries and mortgage-backed securities ‘in the amounts needed’ to keep markets functioning and mortgage credit flowing,” says Greg McBride, CFA, Bankrate chief financial analyst. “Nothing like a blank check from the Fed to keep credit flowing so homeowners can refinance mortgage rates at record low levels.”

How the near-zero Fed rate can impact HELOCs, ARMs

Although the fed funds rate is near zero, which means low borrowing rates for short-term loans such as HELOCs and ARMs, many lenders are either tightening restrictions on who can get a loan or suspending certain loan programs, like HELOCs, altogether. Chase is one such lender that’s no longer offering HELOCs, as they focus on refinancing.

ARM borrowers might face the same hurdles as lenders are tightening their credit and raising their minimum borrower qualifications, making it tougher for consumers to get a mortgage.

Last week, mortgage purchase loan applications were at their lowest level since 2015, and were over 30 percent lower than a year ago, says Joel Kan, associate vice president for industry surveys and forecasts with the Mortgage Bankers Association.

“From a collateral standpoint, a mortgage comes first and a HELOC comes second,” says Mark Hamrick, Bankrate’s senior economic analyst. “When banks aren’t sure what’s going to happen, they don’t want to risk not getting paid on that second loan.”

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.

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 and those looking for a mortgage should do

Would-be homebuyers interested in a fixed-rate mortgage or those who want to refinance should take advantage of today’s super-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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