Feds Continue to Raise Rates

The Feds continued with their planned quarter point short-term interest rate rise, raising the short-term interest rate to 3.25% yesterday. One of the reason, many argue, that housing prices have seen such a sharp increase over the past several years was due to the fact that we've been enjoying the lowest interest rates in history. With borrowing money being so cheap, many folks have been able to afford more house or refinance, pulling equity out of their current home and, perhaps, actually lowering their monthly debt burden while doing it.

However, with the continued rise in rates, the gravy days of the past few years will soon be history, and such a rise in interest rates will make homes more 'expensive' since it will cost more to borrow the same amount. Of course, the short-term interest rate doesn't directly effect long-term interest rates, as evidenced by the past few months which have seen fixed-rate mortgages sink to the lowest rates in years. However, adjustable-rate mortgages are more closely aligned with short-term interest rates, and the Fed's increases in these rates may put pressure on those who were able to buy more house than they could afford using an ARM.

From an MSN Money article, How High Will the Fed Go?, there's the following foreboding omen for those who overextended themselves and used an ARM (emphasis mine):

"Rates on ARMs are primarily tied to short-term indexes, such as LIBOR, the one-year Treasury or the 11th District Cost of Funds. As the Fed boosts short-term interest rates, ARMs are far more sensitive after the fact than fixed-rate mortgages. For borrowers facing rate adjustments, the relevant comparison is the current level of the underlying index, plus the loan's margin, vs. the initial start rate. As short-term interest rates rise, this contrast will expand and lead to some unpleasant rate adjustments for borrowers who took out ARMs at record-low interest rates. Consider a one-year ARM taken out in June 2004 when the prevailing national average was 4.4%. Now facing the first rate adjustment, with the one-year Treasury yield currently 3.37% and a loan margin of 2.5%, the rate could jump to 5.87%. For a buyer who borrowed $200,000 one year ago, the monthly payment increases by $176. Further interest rate increases mean the borrower is likely to face another increase next year. ... It is important for borrowers using ARMs to consider the impact on their monthly payments once the interest rate adjustments begin."

Another way to finish that paragraph: Remember when you asked the piper to play you a tune? Well, he's done now, and you need to pay him.

Could we see an uptick in motivated sellers and even foreclosures over the next several years as the Fed continues to bump up the short-term interest rate and those who bought property with ARMs quickly find that the new, increased monthly debt burden is more than they can handle? And could this be the catalyst for the housing bubble to pop?