How Interest Rates Affect Home Mortgages
People in the market to buy a home may notice changing interest rates in the news - especially in todays rising interest rates environment. Since interest rates tend to rise or fall slowly over many months or years, home buyers may have difficulty understanding why experts concern themselves so much with the issue. In fact, interest rates can often dictate part of the housing market's health, including home prices and what a homeowner may have to pay for a mortgage each month. Because of this, home buyers should understand various aspects of mortgage interest rates, and how they can affect the mortgages people can get to buy a home.
Why Do Interest Rates Rise and Fall?
Although interest rates trends tend to shift gradually, they move up or down quite often. Home buyers may hear that interest rate changes come from the government. This is partially true. The Federal Reserve controls several different interest rates, including the loans banks give to each other. Mortgage interest rates are related to these rates, especially longer term rates, such as the 10-year Treasury Note interest rate.
When the Federal Reserve predicts rising inflation or an over-heating economy, they may begin periodically raising interest rates. As a result of increasing interest rates, the economy may begin to cool, while also deceasing inflation. Sometimes however, increasing interest rates may also have a cooling effect on home sales, as it makes it more difficult for people to obtain mortgages and discourages homeowners from selling.
What Interest Rate Can Home Buyers Get?
The interest rate that a buyer can secure depends on a number of factors that may be inside and outside their control. These include:
- time of mortgage application
- home buyers' credit history
- mortgage type and term length
- lender preferences
Like gasoline prices, mortgage interest rates fluctuate by the week, and sometimes by the day. Buyers who are getting ready to make a purchase within the year may benefit from looking at recent trends. As buyers evaluate their mortgage options, they should consider the difference between the nominal and effective interest rates. The nominal rate is the interest charged annually for the loan. The effective rate includes the interest plus expenses due at closing. As such, comparing nominal rates between loans may be a more useful comparison for planning after the closing date.
How Do Interest Rates Effect Monthly Mortgage Payments?
For most Mountain Trails home buyers, the largest portion of the monthly mortgage payment is interest - at least for the first few years of the mortgage. During the first few years of a fixed rate mortgage, homeowners may pay almost all interest and only a little principal. In this way, a change of only half of a percentage point could make a significant difference in the monthly mortgage payment. For example, a home buyer obtaining a 30-year fixed-rate mortgage on a home costing $300,000 with a down payment of $60,000, could save about $75 per month with an interest rate loan at 4.5 percent vs. 5 percent. This amount may not seem like much, but it does adds up over a 30-year loan.
Can Interest Rates Change Buying Power?
When buyers are limited by the amount of monthly payment they can afford, the interest rate also affects buying power. Lenders usually set a cap on the percentage that the monthly mortgage payment can take of applicants' gross income. For some home buyers, a difference of $75 could represent a significant difference in what they might be able to purchase. So home buyers who can obtain lower interest rates on their mortgages do have the potential to buy a more costly property.
Should a home buyer see that interest rates are on the rise, they should ask mortgage lenders about an interest rate lock. Some lenders offer locks on the interest rate at the time of application or at the time a buyer secures a purchase contract for a particular property. A lock guarantees a particular rate for a specified amount of time, typically 30-60 days, assuming nothing about the application changes. Lenders may or may not charge a fee for this feature. For buyers who are at the upper limit of their buying power, a lock may serve as a form of protection for their ability to close on the loan.
What Can Buyers Do to Get a Better Interest Rate?
Apart from an interest rate lock, buyers may want to do everything they can to get the best interest rate on their mortgage as possible. Mortgage applicants who have:
- higher or long-term steady income
- good or excellent credit
- a larger down payment
- plenty of assets in reserve
are more likely to get lower interest rates on their home mortgage loans. Since lenders vary the rates they offer, buyers may get better results by applying through more than one lender.
Mortgage interest rates are an important part of the home buying process. When buyers understand what current rates could mean for their buying power, they can form a more-educated plan for the future.