For Michelle Higgins and her husband, John Kohan, the latest signals from Federal Reserve officials on interest rates are an encouragement to pay down the principal on their home equity line.
A half-point increase in rates will add $25 a month to the Silver Spring couple's payments, Higgins said. "It's not horrible," she said. "But it has encouraged us to try very hard to pay [the principal] off, or at least reduce it by half."
For most homeowners, particularly the millions who took out lower, fixed-rate mortgages in last year's unprecedented refinancing boom, an upward movement in rates will have little impact.
But for others -- those with certain adjustable-rate mortgages, construction loans or home equity products tied to short-term interest rates -- bigger monthly payments are almost certainly around the corner.
This week, Freddie Mac adjusted its interest rate and home-sales forecasts for the year, predicting that higher rates will drag sales below earlier predictions. The mortgage financier still predicts sales of new and existing homes will remain above last year's record 7.19 million.
"There's only a small portion of the mortgage marketplace that will be affected by the Fed starting to hike interest rates," said Keith Gumbinger, vice president of New Jersey-based financial publishers HSH Associates. "But those borrowers will soon feel the effects."
When rates hit 46-year lows last summer, 90 percent of the new loans taken out by homeowners were fixed-rate loans, said Frank E. Nothaft, senior economist at Freddie Mac. "American consumers are very savvy that way," he said. "They know a good deal when they see one."
Adjustable-rate mortgages, or ARMs, usually carry a lower rate upfront than do fixed-rate loans. They've become more popular as mortgage rates have risen in the past few months. Last week, according to the Mortgage Bankers Association, ARM applications accounted for 34.6 percent of all mortgage applications.
Average rates on 30-year fixed loans this week were 6.30 percent, up from 6.28 percent last week, according to Freddie Mac. A year ago, rates on 30-year mortgages averaged 5.21 percent. One-year ARMs this week averaged 4.14 percent, compared with 3.54 percent a year ago.
Most of the ARMs that consumers take out now are so-called hybrid loans, in which the initial interest rate is fixed for a relatively long period of time -- three, five, seven or 10 years. Those homeowners won't be immediately affected by rising rates.
The borrowers who will be affected are those who hold loans that adjust after a short period of time, such as monthly, every three months, every six months or once a year. "Mortgage delinquencies will probably rise a bit because of the Fed moves," said Doug Duncan, senior economist with the Mortgage Bankers Association. "People have to adjust to the process of adjustable-rate products. Delinquencies are always higher with ARMs."
The mortgage bankers' group predicts that the Federal Reserve will increase short-term rates a quarter of a percentage point three times before the end of this year.
Another group of homeowners facing higher payments are those like Higgins and Kohan who hold loans tied to short-term interest rates such as the prime rate.
Home equity lines in particular are commonly tied to the prime rate, which is now 4 percent but is likely to rise along with any Fed rate increase.
By the end of 2003, Americans held $375 billion in home equity loans and lines of credit, according to figures from Freddie Mac. For every quarter-percentage-point increase in the prime rate, the amount of additional interest payments owed by these borrowers would jump by $938 million over the course of a year, Nothaft said. "It does add up."
Most borrowers don't seem that concerned yet, though. Many are paying a lower interest rate on their home equity lines and construction loans than they are on their primary mortgages.
"What's there to worry about?" asked Carrie Staples, a mortgage broker at Sigma Financial in Bryans Road, Md. "Short-term rates have been ridiculously low for such a long time. We've been living in a fantasy world."
Staples said that payments on her own home equity line of $75,000 will go up only $31.25 a month with a half-point rise in short-term rates.
And Nothaft said most home equity lines of credit are not that large, generally about $20,000. Economists said those homeowners concerned about rising payments on their variable-rate loans should either roll their home equity lines, loans or construction loans into their primary mortgages or try to pay down some of the outstanding principal.
Higgins isn't panicking but feels the time has come to try to reduce the principal on her home equity line. Rates "are going to continue to go up. It's just that time" to take action.