Understanding mortgage interest rates

Understanding mortgage interest rates

Locking down a good mortgage rate is just one important aspect of home affordability. If you’ve been thinking about buying a home, you may be wondering what affects mortgage interest rates & what climbing rates mean for you.

Mortgage rates have been on the rise, and they will likely continue to do so. As of June 2018, the average mortgage interest rate for a 30-year fixed-rate loan is 4.76%, but it won’t stay that way forever.

We’ll talk more about how these rates work, why we’re seeing them continue upward, and how this affects those who are in the market for a home. By the end of this post, you’ll have a whole new appreciation for the process.

How mortgage interest rates work

The way mortgage interest rates are determined is notoriously complicated. But, it mainly boils to two factors: the strength of secondary markets and your financibility as a consumer.

Secondary markets refers to financial trades. When the bank grants you a mortgage, they don’t keep your debt in-house. If they did, they’d have to wait years for the payoff.

Rather, they often sell it off quickly to a third-party investor known as a mortgage aggregator. The aggregator then packages your debt along with many others into what’s called a mortgage-backed security. Finally, the security is divided into shares and sold among individual investors.

The profit margins on these securities determine how likely the individual investors are to buy these funds, and, as such, how frequently banks can take the risk of granting someone a loan. That, along with other factors, helps determine the average interest rates each month.

That said, the average interest rate is not a guarantee. The rate you personally receive may be higher or lower. The mortgage company will determine the interest rate that they’re willing to offer you based on how big of a risk they feel that they’re taking in lending you a large sum of money.

For that, they look at a variety of factors such as your credit score, debt-to-income ratio, and the size of your down payment. Generally, the better these numbers are, the lower your interest rate will be.

Why interest rates are rising

Essentially, as the economy starts to heat up, so do interest rates. Again, this is due to a variety of factors. However, attention can be drawn to slightly rising wages and the GOP tax cut, which were both announced around the time that interest rates first began to climb in January of this year.

When there’s a positive outlook on the economy, a number of things happen. For one, the individual investors who bought into the securities begin to expect a larger return on their investment, which forces lenders to raise rates in order to compensate.

For another, the Federal Open Market Committee (FOMC) must adjust the Federal Funds Rate, or the interest rate at which banks can borrow money from other financial institutions in order to give out loans. In a good economy, the rate rises in order to stop inflation from getting too high. The banks then pass this cost onto you, the consumer, in the form of a higher mortgage interest rate in order to ensure that they’re still turning a profit.

How rising rates affect house hunting

As for how all this affects house hunting, it may provide an incentive to start buying something sooner rather than later. That way, you can lock into a rate while they’re still relatively low. After all, even though a few percentage points may not seem like a big deal at first glance, they can vastly effect how much you’ll pay, in total, over the life of the loan.

For example, according to Investopedia:
“If the interest rate on our $100,000 mortgage is 6%, the combined principal and interest monthly payment on a 30-year mortgage would be something like $599.55 ($500 interest + $99.55 principal). The same loan with a 9% interest rate results in a monthly payment of $804.62.” Just imagine what the difference in payment would be on a home that cost $300,000 or higher.

Rising interest rates will likely also have an effect on whether you’re looking for a fixed or adjustable-rate loan. With fixed-rate loans, you’re locked in to paying the same interest rate over time, no matter what happens in the market. With adjustable-rate ones, you’re at the mercy of market value.

Now more than ever, your smartest financial move would be to make sure that you’re locked in to a rate that’s as low as possible.

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