Who will be hurt when the Fed raises rates?

So, when the Fed raises rates this time, who will be hurt the worst?

First things first: the Fed controls the overnight cost of money, the “Fed funds” rate, not mortgage rates. Only twice in the Fed’s history has it directly influenced long-term rates: WWII to the Korean war, and during Quantitative Easing (QE) from 2009 to 2014.

Long-term rates — like mortgages — are set by markets and often behave perversely. As now. Short-term Treasurys and indices like Libor are rising, but not mortgage rates.

Until — if — mortgage rates rise, nobody is hurt except existing ARM (adjustable-rate mortgages) and home equity borrowers, and those who are thinking of taking out a new ARM while the Fed is tightening (not a great idea).

Long-term rates rise when the Fed is tightening if markets think the Fed has a long way to go. In 1994, the Fed hiked from 3.00 percent to 6.00 percent in less than a year, and mortgages ran up from 6.75 percent to 9.75 percent. This time the Fed is likely to be much more gradual, hiking slowly over several years.

Long-term rates also jump when the bond market thinks the Fed is “behind the curve” — too slow to tighten and giving inflation a running start. Not now — if anything, the dominant bond market opinion holds that the Fed is taking significant risk by tightening at all.

Back to “who’s hurt” if rates do actually jump. A 1-percentage-point rise in rate equals a 7.5 percent increase in the principal and interest payment. Peanuts. If $1,000 before, $1,075 afterward.

Consumers will feel it, but the psychological harm going from 4-something to 5-something is always greater than the payment shock itself.

Some say first-time buyers will be hurt worst. Based on the parade of clients we see in the real world, the choke point for first-timers is not the mortgage payment.

It’s these two things: First, young people have a very hard time accumulating a down payment. They are laden with student loans and health insurance expenses, and even if they save, their savings don’t earn anything.

Second, income instability is more troublesome to the youth set than income altitude. Youth face sudden switches to contract employment from salary, or from high-base to high-incentive — both mortgage killers.

Last things last. Mortgage rates are not going to run up unless and until inflation does, and this Fed tightening is entirely pre-emptive of inflation not on any radar.

“Who is hurt?” If the Fed overdoes its tightening, everyone gets hurt by an unnecessarily weakened economy.

Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.