READ THIS BEFORE YOU CONSIDER A HELOC (or Refinance)
There are a lot of misunderstandings about what The Fed does when it “raises rates” and the impact it has on mortgage rates.
The Fed has limited policy tools when it makes monetary policy, one of those is the Fed Funds Rate, an overnight lending rate.
However, this does not directly impact mortgage rates.
Instead, mortgage rates are derived by the mortgage bond market and the price investors are willing to pay for a given mortgage coupon.
Each coupon covers a half-percent (0.50%) spread of mortgage rates, and depending on what rates fit into a given coupon will determine what a borrower will need to pay for certain mortgage rates.
In reality, mortgage rates do not rise or fall, instead the price for a given interest rate is what actually changes.
The reason mortgage rates increased so quickly in 2022 had very little, if anything, to do with the Fed and their decision to raise the Fed Funds rate.
In fact, mortgage rates had already jumped higher in the first two-months of last year. This was before the Fed began raising rates and long before any of the meaningful 75 basis point (0.75%) rate hikes they announced during the summer.
The reason why mortgage rates skyrocketed higher, which is the same reason The Fed started hiking rates aggressively, was because year-over-year inflation reached a level we had not seen in 40-years.
Inflation reduces the principal value of a bond and as a result investors reduce their bond holdings when inflation is increasing, especially at the highest rate-of-change in 40 years.
When there are more sellers than buyers, the price of bonds fall. The yield (rate) on a bond increases as its price falls. The same is true of mortgage bonds.
Mortgage rates increased during 2022 not because of the Fed, but because of the immense selling pressure in the bond market that was triggered by inflation.
I explain the relationship between mortgage rates and mortgage bonds in my eBook “The TRUTH About Mortgage Rates”.
You can DOWNLOAD IT HERE.
For more information about why mortgage rates do not actually rise or fall, I suggest you read my article “GAME OF LOANS.
I also discussed the topic in an EPISODE of the Mortgage Guru Podcast which is available on my YouTube Channel.
There is also a SHORTENED CLIP from that episode covering just this topic.
THE 7 THINGS
I realize I just provided you with a lot of information, but a foundation was necessary prior to me sharing the 7 Things You Need to Know Before You Get a HELOC (or Refinance).
Now that I have covered some of the basics, and provided you with additional resources, we can begin.
Most homeowners have a record low fixed rate from 2020 – 21.
Despite interest rates of all-types skyrocketing the last 12-months, the spending habits of most people has not changed.
Homeowners grew accustomed to paying off debt with a first mortgage refinance at lower and lower rates but are now looking for new ways to consolidate debt without touching their primary mortgage.
One option that many are exploring, and has been aggressively marketed by lenders, are HELOC loans.
However, before you make a decision about a HELOC or a refinance, consider these 7 Things…
- HELOC stands for Home Equity Line Of Credit
- HELOCs are 100% a mortgage
- Ignore word play by advertisers
- HELOCs are revolving mortgages that function like a credit card
- Adjustable rate HELOCs have a “Floor Rate”
- HELOCs are tied to indexes sensitive to Fed rate decision
- Interest rates on conforming mortgages are less impacted by the Federal reserve
HELOC mortgages can be in any lien position.
This means they can be the first and only mortgage, but are usually subordinate or secured behind another lien, typically a fixed rate AMORTIZED mortgage.
This is true of any loan that uses your home as collateral.
HELOC is financing that changes the total debt or liens against your property, so it is a form of “refinancing”.
There are many dishonest advertisements that say “don’t refinance, instead do a HELOC”.
When you get a HELOC it is a refinance, they are the same thing.
If you see ads that say something different, ignore it, because if these companies cannot be honest upfront then what kind of games do you think they will play when it comes to the actual loan.
This means the payment is calculated from the total outstanding balance, and much like a credit card the money can be used again after it is paid back without applying for a new loan – a key advantage of a HELOC.
However, just like a credit card HELOCs usually have adjustable rates – they combine a margin which is fixed, with an index that is variable, to determine the new rate when it adjusts.
This means once a HELOC adjusts, regardless of the result of adding the margin and index, the new rate will NEVER be lower than the FLOOR RATE.
This restricts how low your rate can adjust. This is bad news when interest rates decline, which is exactly what is about to happen and alway happens at the end of a Fed rate hiking cycle.
The Fed is still battling inflation and has raised their overnight lending rate by more than 4%.
So, what happens to HELOC rates during Fed hiking cycles?
Remember, when a HELOC adjusts the new loan is determined by adding the margin, which is fixed, with an index, that is variable.
Most HELOCs are tied to indexes sensitive to Fed rate decisions. This means HELOC rates tend to follow the path of the Fed overnight lending rate and therefore are currently rising fast.
Most fixed rate amortized mortgages meet “conforming” loan criteria and are packaged into mortgage-backed securities.
Unlike HELOCs, the rates on conforming mortgages are less impacted by the Federal reserve, but instead are determined by the price of mortgage-backed securities and their bonds.
In fact, conforming rates tend to decline when the Fed is hiking.
I introduced this concept in the intro to this article and I go further into the details in my eBook “The TRUTH About Mortgage Rates” which you can DOWNLOAD HERE.
You can also watch a VIDEO ON INSTAGRAM I posted about the 7 things you need to know before you get a HELOC.
RATE SHOCK
The opportunity to refinance using a HELOC was early 2022. Yet, anyone who did is about to have a rude awakening.
Short-term interest rates continue to rise which means payments on HELOCs and credit cards have also increased.
Meanwhile, fixed rate mortgages peaked in November and are declining.
Homeowners looking for ways to reduce their monthly debt payments, who have not yet completed a HELOC, should consider a fixed rate alternative.
If you need cash-out, or help finding payment relief on your rising interest rate debts, contact me to learn about our BLENDED RATE refinance strategy.
The Blending Rate Refi protects you against the dangers of adjustable rate HELOCs and allows you to keep your current low-rate first mortgage.
We are at the beginning of a massive reversal in fixed mortgage rates.
My goal is to help homeowners from making a poor refinance decision today and missing out on the low-rate opportunities just around the corner.
To learn more about the BLENDED RATE REFI and to position yourself for the next “Big Rate Drop” please CONTACT ME today.
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