Interest rates are going up. The Federal Reserve just hiked rates for the second time in 2018. And there could be two more rate hikes before the end of the year. What does this all mean for potential home buyers?

Let’s start by understanding the Federal Funds rate

The Federal Reserve controls the Federal Funds rate, the interest rate everybody is referring to when discussing rising rates. The Federal Funds rate is the interest rate in which banks lend to each other, not to you or me. There’s generally a minimum reserve requirement ratio a bank must keep with the Federal Reserve or in the vaults of their bank, e.g. 10% of all deposits must be held in reserves. Banks need a minimum amount in reserves to operate, much like how we need a minimum amount in our checking accounts to pay our bills. At the same time, banks are looking to profit by lending out as much money as possible at a spread.

What does all this mean for homebuyers?

There’s good news in that rates are still at historically low levels. Increases mean it will cost more to borrow, but higher mortgages could push buyers to go ahead and purchase a home, which will increase demand and prices while raising home equity so more people can sell their homes.

Regarding home prices, there is some good news, as over time prices should start to come down as interest rates go up. As rates rise, fewer people can afford homes and this creates a decrease in the number of potential buyers, which translate to more inventory. Potentially, homes will sell for less once the initial rush of buyers has come and gone.

As interest rates increase, it won’t necessarily change your ability to qualify for a mortgage. Mortgage lenders review your credit score as well as your debt-to-income ratio. How rates are trending is likely to have less of an impact than these other two factors.

Interest rates play a key role in determining how much house you can afford. As interest rates increase, you may find that you can no longer afford that house you wanted and could have purchased. But, the same house should eventually decrease in price to a place that is in line with the amount you can afford.

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