Have an Adjustable-Rate Mortgage? Here's What the Interest Rate Hike Means for You

Federal funds rate increases trickle down to other variable rate products.

Over the last few years, new home buyers have enjoyed some of the lowest mortgage rates in decades. This year, that trend took a serious about-face, and mortgage rates have been steadily rising.

In 2022 alone, the average rate for a 30-year fixed-rate mortgage has jumped 2%. New buyers are now looking at an average rate of 5.4% for the same 30-year loans.

And it may get worse from here. Just this week, the Federal Reserve announced an interest rate increase of 50 basis points -- 0.50% -- the largest increase in more than 20 years. For consumers, this means any debt based on the federal funds rate (a key index in many variable rates) could get more expensive.

ARM rates likely to follow Fed hike

In the mortgage world, the most immediate response to the increased federal funds rate may be felt by those with, or interested in, an adjustable-rate mortgage (ARM). Many ARM loans are indexed to the federal funds rate, meaning they vary as that rate varies.

While the increase may not be immediate, ARM rates will likely respond to the Fed increase sometime soon. How that could impact you will depend on where you are in your ARM progress.

If you have yet to get a loan, you'll see higher rates as you shop around. If you already have an ARM, how long you've had it will be the largest factor.

Most adjustable-rate mortgages have a period of fixed interest at the start of the loan. For example, a 5/1 ARM will have a fixed interest rate for the first 5 years. Similarly, a 7/1 ARM has a fixed rate for the first 7 years. That fixed rate won't be impacted by the Fed increase.

Outside that period, however, ARM loans are subject to annual rate adjustments. And the new rate you receive will most likely reflect the Fed's latest increases. But wait, there's more.

More rate increases likely to follow

While this week's rate increase was a major deal, there's a good chance it won't be the last we see this year. Fed Chairman Jerome Powell has indicated the central bank is actively considering additional rate increases in June and July.

Each of those increases could be as high as a half-percentage point. However, Powell also said rate increases larger than that weren't being considered at this time.

This latest increase already raised the federal funds rate to between 0.75% and 1.00%. The additional increases would bump that up to 1.75% to 2.00% -- a stark increase from the low 0.25% to 0.50% rates we've had until now.

With additional increases already seemingly in the works, it could be late summer before many banks react with their own rate increases. Or, you may simply see multiple increases after each meeting. Either way, it'll likely be late summer before most consumers start to feel the effects.

How much impact the rate increases will have on inflation remains to be seen.

It may help reign in the housing market

If there's a potential silver lining for home buyers in all these mortgage rate increases, it's that it may help reign in the overheated housing market.

Essentially, if it's more expensive to get a loan, fewer people can afford them. This will mean fewer buyers, decreasing the competition -- and, thus, the power of sellers.

The big jump in mortgage rates may already be impacting the housing market, as existing home sales declined in March. Housing prices have also seen a modest decline.

For many, the decrease in housing prices -- and the bidding wars brought on by stiff competition -- may actually make buying a house more affordable, even if mortgage rates increase further. At the very least, it should become easier to find a house to buy if they're staying on the market longer.