The news today is full of stories about the Federal Reserve increasing the Fed rate 0.25%.

A lot of stories say the increase was “25 Basis Points” which is financial geek speak for one-quarter of a percentage point, 25 basis points = 0.25%.

[BTW, I was psyched to be quoted in the Washington Post yesterday about the Fed rate increase. You can read the article here. In the post below, I dive into the rate increase with a bit more detail.]

What you need to know

1. Mortgage rates don’t follow Fed rates closely at all.

2. Higher mortgage rates aren’t necessarily bad in the short and medium term.

3. Some people will now buy sooner to avoid the expected higher mortgage rates later.

1. Mortgage rates don’t follow Fed rates closely at all.

Fed rates and mortgage interest rates are very loosing connected. A Fed rate increase of 0.25% does not at all mean mortgage rates will increase by 0.25%.

Look at 2004 to 2006 in the graph below. It’s a good example of how loose the relationship is. The Fed rate went up about 4% from 2004 to 2006 but the actual mortgage rate only went up less than 1%.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=2VWj

Nevertheless, when Fed rates go up, it’s a lot more likely that mortgage rates will go up rather than down. That means we’re likely to see mortgage rates increase in 2016. That’s pretty much the conventional wisdom right now.

The National Association of Realtors is forecasting that mortgage rates will average 0.5% higher in 2016 than in 2015. That’s a reasonable guess. It could very well mean that mortgage rates will start out 2016 near where they are now but end 2016 about 1 percentage point higher than they are now. We’ll see.

2. Higher mortgage rates in 2016 don’t necessarily mean that home prices in 2016 will fall.

A lot of factors determine home prices. Mortgage rates are just one.

For example, mortgage rates rose from 2013 to 2014 – increasing the monthly cost to home buyers – but home prices increased sharply anyway.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=2W2y

3. Expectations of higher mortgage rates in 2016 will cause some people to buy sooner rather than later and that could actually boost the real estate market in the short and medium terms.

We saw this effect during 2004 and 2005. When the Fed began to rapidly increase the Fed rate, the real estate frenzy got even worse. Prospective home buyers, very rationally, expected mortgage rates to increase in the future so they bought ASAP which stoked the real estate boom.

The 2015 real estate market, of course, is very different than the wild and woolly 2004 real estate market so the effect may not be the same. I, however, think the rational expectation that mortgage rates will increase in the future will cause many people to want to buy sooner rather than later.

Takeaways

U.S. home prices and home sales are likely to increase in 2016, despite the expected mortgage interest rates increases.

First-Time Home Buyers. If you’re seriously considering buying a home, consider buying sooner rather than later. It’s looking like U.S. home prices and mortgage rates will both increase in 2016.

Home Sellers/Buyers. You’re fine. If you’re selling and buying at the same time, it pretty much doesn’t matter when you buy or sell. What’s good for one is bad for the other and vice versa.

Home Sellers in San Francisco and Seattle. Consider selling sooner rather than later. When it becomes clear that the tech bubble is bursting, everyone’s going to head for the exit at the same time. But that’s a post for another time.

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