One-year adjustable-rate home mortgages rose slightly last week, responding to Wednesday's decision by the Federal Reserve Board to raise a key short-term interest rate for the first time in four years. Fixed-rate mortgages - the most popular kind of home loans - declined.
The Fed - which raised the federal funds rate by a quarter percentage point to 1.25 percent - is expected to keep inching rates higher for the rest of the year, a move to limit inflation by raising the cost of borrowing money. The action will directly affect homeowners who financed with adjustable-rate mortgages, or ARMs.
About 35 percent of homebuyers are choosing ARMs, which are one way consumers cope with rising interest rates, said Doug Duncan, chief economist for the Mortgage Bankers Association.
While they provide lower interest rates initially, many ARMs don't have a locked-in rate, making them directly vulnerable to Fed action.
"One of the big risks to homeowners is having a mortgage that faces rate adjustments when rates are rising from historic lows," said Greg McBride, a senior financial analyst with Bankrate.com in Florida. "This could lead to unpleasant surprises in terms of interest rates and monthly payments."
The rate for a 30-year fixed-rate mortgage fell to a national average of 6.21 percent, compared with 6.25 percent the previous week. Rates for 15-year fixed mortgages also declined slightly to 5.62 percent. Both rates have risen almost a full percentage point over the past year. One-year adjustable-rate mortgages averaged 4.19 percent - up 0.06 percentage point from the previous week. The rate a year ago was 3.45 percent.
Fixed rates escaped unscathed last week because of market foresight, said Amy Crews Cutts, deputy chief economist with Freddie Mac. When the Fed hinted at rate increases in March, the mortgage market began phasing in the anticipated rise, slowly increasing the cost of home loans, she said.
Those rates are predicted to continue rising during the coming months, as the mortgage market braces for more short-term interest rate boosts by the Fed. The increases since March already have slowed refinancing activity, leading some economists to predict problems for a housing market that has posted record sales during each of the past three years.
Real estate agents disagree, saying they don't anticipate much of an effect on the housing market. While interest rates have climbed during the past few months, they remain at historic lows and continue to push many first-time buyers into the market. And, agents said, many people are trading up because they have so much equity in their current homes. Home price appreciation reached double digits during the past two years, in part because of the historically low mortgage rates.
"I can't tell you how many of our customers were not planning on moving, but then they saw how much their neighbor sold their house for," said Columbia Realtor Pat Hiban.
Even if interest rates rise 1 percentage point or 2 percentage points from their current levels, Hiban said, the housing market would still be in good shape. The market has slowed a bit, Hiban noted, but it's a trend he attributes to increased inventory.
Still, rising rates do affect what people can afford, said Gilbert Marsiglia, president of the Maryland Association of Realtors.
Buyers lose in two ways: They are able to afford less, and lower-priced markets become saturated with competition.
A rise of half a percentage point in mortgage rates will drop a consumer's buying power by 5 percent, Marsiglia said. If a buyer was looking at houses in the $250,000 range, he or she would have to shop for houses priced around $238,000 or less to afford the same kind of monthly payment.
"There's been a general feeling in the marketplace for maybe a month or two that rates were going to go up," said Marsiglia. "I think the buying public realized it six to eight weeks ago, and a number of people came out of the woodwork to buy before rates went up." But for those who haven't made their move, experts said it is not too late.
"Moving into 2005, we might see the breaks go on in the housing market," said Cutts. "If a consumer is wondering if they should buy, sell, or refinance, it's still a good time to think about those things."
Last week's mortgage rates do not include mortgage costs, such as points. The average fixed-rate mortgage carried 0.6 point, while the one-year ARMs carried 0.7 point, according to Freddie Mac. A point is one percent of the loan.