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The Fed Funds Rate and Unconventional Wisdom

Conventional wisdom suggests that rising Fed Funds rates are bad news for the still-recovering US Housing Market. And it’s easy to see a scenario unfold that supports this theory: lenders react to the Fed action by raising interest rates on mortgages; these higher interest rates, coupled with strong home price appreciation make housing less affordable, especially for homebuyers who were already uncertain that they could actually afford a home; and with consumer psychology being what it is, many other potential buyers would simply assume that the market was too expensive to enter, opting to stay on the sidelines. Lower affordability and less demand certainly don’t paint a pretty picture.

Fortunately, conventional wisdom is often wrong, and there are several reasons why it might be wrong in this case:

First, while there will be an effect on consumer psychology, it might actually be the opposite of the above scenario: seeing the Fed raise rates in 2017, and with two more rate increases this year likely, potential homebuyers will get into the market in order to buy a house before rates go any higher.

Second, higher interest rates may provide enough of a financial cushion to encourage lenders to loosen some of the incredibly tight lending standards that have prevented millions of credit-worthy borrowers from getting mortgages. Higher rates will also drastically reduce the number of refinance loans being issued, which lenders may try to offset by doing more purchase loans.

Third, while interest rates are likely to go up, rates on a 30-year fixed rate loan are still almost two points lower than the average interest rate paid by borrowers over the last 25 years, and home prices in all but the most overheated markets across the country are still very affordable by historical standards.

Finally, since the 25 basis point hike was well within the range that most industry analysts had expected, rates may not go up as much as expected, at least for the time being.

This is admittedly a much rosier scenario – motivated buyers, relaxed lending standards, and marginal mortgage rate increases, coupled with what appears to be strong wage and job growth. And if unconventional wisdom prevails, the spring selling season could be the strongest one we’ve seen in many years.

About Author: Rick Sharga

Rick Sharga is EVP of Ten-X. Before joining Ten-X, Sharga was EVP at Carrington Mortgage Holdings and a SVP at RealtyTrac.
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