Rising Rates Ripple Through Mortgage Market

    Experts warn homeowners of sticker shock ahead, as interest rates on adjustable-rate mortgages and home equity lines of credit are expected to creep up the increase in the Fed rate Wednesday means the cost of borrowing is likely to rise, especially for home-equity lines of credit and adjustable rate mortgages. The era of ultralow mortgage rates is over.

    The Federal Reserve’s decision to raise the federal-funds target rate by a quarter of a percentage point Wednesday means borrowing is about to get more expensive for consumers.

    Some homeowners also will feel the pain, in particular those who signed up for home-equity lines of credit, adjustable-rate mortgages (ARMs) and other variable-rate loans. Interest rates on these loans tend to rise after rate increases, resulting in larger payments for borrowers.

    The Fed’s rate increase is the second blow in the past five weeks for mortgage lenders and borrowers. Rates on plain-vanilla, 30-year fixed-rate mortgages have surged since Election Day by 0.76 percentage point, bringing them to an average of 4.38% on Thursday—their highest rate since April 2014, according to MortgageNewsDaily.com.

    Mortgage lenders have slashed 2017 refinance-volume expectations for 2017 nearly in half, although they are banking on buyers rushing in to get mortgages before rates rise further. To keep purchase volume going, several large lenders are talking up the benefits of ARMs that feature fixed rates that are lower than a traditional 30-year mortgage for the first five or seven years.

    Regular mortgage rates move in tandem with the yield on the 10-year Treasury, which has risen sharply since Election Day. The Fed rate increase will impact home-equity lines and, to a degree, ARMs.

    Of course, interest rates on consumer borrowing remain very low across the board. Increases in borrowers’ payments from this week’s decision will be relatively small and for some borrowers offset by rising wages. But analysts warn that continuous rate increases of the same magnitude over the next year—a possibility that the Fed signaled—could result in home loans becoming less affordable for new borrowers and in more delinquencies among homeowners with variable-rate loans.

    “This economy has gotten so conditioned to 2% and 3% mortgage rates that there is sticker shock,” said Chris Whalen, senior managing director at Kroll Bond Rating Agency Inc.

    The most immediate pain on the home-loan front will be felt by homeowners shopping for home-equity lines of credit, or Helocs. These are typically used by people who want to borrow against the value of their home for renovations or other purposes.

    Interest rates for these lines, which are typically variable, have already increased, says Keith Gumbinger, vice president at mortgage-information website HSH.com. Existing Heloc borrowers will see an increase in their interest rate and monthly payments within the next one to three billing cycles, he said.

    That would be a second hit to some Heloc borrowers struggling to make payments. Most Helocs require interest-only payments during the first 10 years, and then principal payments kick in.

    Delinquencies have been rising as millions of these loan-payment resets have been under way or are coming up.

    More than 600,000 Helocs originated in 2005 were still active this past spring, in addition to more than 840,000 originated in 2006 and another nearly one million in 2007, according to Equifax. These borrowers will have to pay more as principal payments come due, while an increase in the overall interest rate will jack payments up further.

    Borrowers with adjustable-rate mortgages also are likely to pay more.

    ARMs are relatively rare, with about 3.4 million in existence, or only 7% of all mortgages outstanding, according to mortgage data-firm CoreLogic . Many of these loans are taken by borrowers because their lower introductory rates make it easier to afford more house, Mr. Whalen said.

    “Borrowers who just barely got into that house by going with the ARM are the ones who are going to default first,” he said. As rates rise, “the cost savings they had in their pocket will disappear [and] by 2018 you’ll see a significant increase in defaults.”

    ARM rates generally move in tandem with either the yield on the one-year Treasury or the one-year London interbank offered rate, or LIBOR. Both have been on the rise in recent months and will likely continue to increase on expectations of more Fed rate increases on the way, said Frank Nothaft, chief economist at CoreLogic.

    The effect on borrowers will depend on what kind of ARM they have and when they signed up for it. Most ARMs have a set number of years, often five or seven, during which the rate is fixed and isn’t affected by rate increases.

    Once that fixed period ends, rates on most ARMs adjust once a year based on the benchmark they are pegged to. Over the life of the loan, rates generally can’t rise by more than 6 percentage points above the initial rate borrowers received when they got the loan.
    Original Content The Wall Street Journal

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