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What the Fed may cost you
Interest rates are heading higher...and that affects a wide range of loans.
August 9, 2005: 2:23 PM EDT
By Les Christie, CNN/Money staff writer
Mortgage Rates
30 yr fixed 4.21%
15 yr fixed 3.27%
5/1 ARM 3.51%
30 yr refi 4.20%
15 yr refi 3.27%

Find personalized rates:
 

Rates provided by Bankrate.com.

NEW YORK (CNN/Money) - At 2:15 p.m. on Tuesday, many homeowners got a big increase in monthly expenses...for the biggest borrowers, increases could run into the hundreds of dollars a month.

The reason, of course, was the meeting of the Federal Reserve, which announced its 10th rate hike in the overnight lending interest rate since last summer.

Exactly how much payments will rise and how quickly homeowners feel the pain depends on the types of loans they have.

Here's a short primer on the hike's impact by type of loan.

Adjustable rate mortgages:

ARMs have the most direct relationship with the Fed rate -- they are pegged to the Libor index or one-year Treasuries, which both track the Fed rate. And any change in those rates are felt by both new borrowers and those with existing loans.

ARMs carry low initial interest rates, usually for the first year, after which the loan's interest rate adjusts. Typically, ARMs can only go up two percentage points annually.

The impact of the Fed increase may be almost immediate and small for some borrowers, because those rates have been adjusting quarterly or monthly and previous Fed hikes are already accounted for.

For others, who haven't yet faced ARM adjustments, the increase could be substantial.

"Rates adjust only at intervals," explains Gregg McBride, senior analyst with Bankrate.com, a personal finance Web site, "but they can be very significant." He says many borrowers who took out one-year ARMs a year ago or borrowers whose rates scheduled for their annual adjustment may see big increases in their bills.

Since the Fed has raised rates many times in the past 12 months, newly adjusted rates may reflect all of those increases up to the two-point cap.

Adding two percentage points on a $216,000 mortgage (the latest U.S. average) could mean paying about $269 more a month. For someone financing a million dollar mortgage that would come to $1,245 more. That hurts!

Fixed rate mortgages:

Unlike ARMs, fixed-rate loans, in which payments are the same the last month of the mortgage as the first, are insulated from any interest rate changes.

But people in the market for new loans, including homeowners considering refinancing, will pay more. Interest rates for fixed-term mortgages are influenced by but not directly pegged to the Fed rate.

"Fixed mortgage rates have been on a slow and consistent rise since the Fed raised rates this June," says McBride. "But a lot depends on what the Fed says rather than what it does."

If Greenspan indicates, as he is expected to, that the Fed plans to continue raising rates in the future, fixed mortgage rates may continue their rising trajectory. McBride says the 30-year rate could hit 6.4 percent by the end of the year; that's about a full percentage point more than today's rates.

A $216,000 30-year, fixed-term loan would cost $1,351 at 6.4 percent, about $139 more than a present 5.4 percent mortgage. An increase of that size could make it more difficult for some buyers to afford the house they want, as well as discourage refinancing among homeowners looking to turn some of their home equity into cash.

Home equity lines of credit:

HELOCs allow homeowners to borrow against their home equity whenever they need to. Interest rates vary monthly and are tied directly to the prime rate, so if you have an outstanding balance, you can count on a quick jump on your bill, although it will probably take a full billing cycle to trickle down.

Some lenders even base their billing on the prime rate from as long as 90 days ago, giving you a three-month respite from rising rates. Of course, it's a double-edged sword; when rates fall, you still pay at the older, higher rate for a longer time.

A year ago, many borrowers with HELOCs were paying what is called a "floor rate." This is the minimum interest rate that a lender will charge. When rates drop, they may fall below the floor, so borrowers are actually paying more than the prime rate would ordinarily dictate. As rates go up from those lows, borrowers don't incur any increases until they reach the floor.

But today, following so many rate hikes, few borrowers would still be at the minimum "floor" level. So any Fed hikes would likely be felt by everyone with HELOCs.

Home equity loans:

Home equity loans are lump sum loans backed by the value of your house. According to McBride, most home equity loans are pegged to one-year treasury yields or the prime, which closely track the movement of the Fed rate.

The majority of these loans carry a fixed rate, however, so most homeowners with existing loans should not see any change.

Homeowners who are considering a home equity loan would be wise to come to a decision quickly. Like conventional fixed rate mortgages, these loans may see interest rate rises of about one percentage point by the end of the year. That would add more than $43 a month to your payment for a $50,000 loan.

Homeowners should understand that borrowing to finance purchases can be risky. Click here for more.

Cash-out refinancings have soared recently. For more, click here.  Top of page

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