Homeownership is the American dream…right?! But mortgage interest rates can make a big impact on your buying power. Rates not only affect your monthly payment, but also the amount of money you pay towards interest over the life of the loan. Think tens (or hundreds) of thousands of dollars difference!
How Home Loan Rates Are Determined
Historically, the Federal Reserve (the Fed) has had a big hand in setting, raising, and lowering the federal funds rate, which impacts mortgage interest rates directly. When it costs banks and credit unions more to lend to each other (which is what the federal funds rate determines) then mortgage interest rates go up.
Before you panic over current rates, consider this: In 1979-1980, the fed funds rate went to 20% -- an all-time high designed to combat double-digit inflation rates. 0%-0.25% marks the all-time low in (you guessed it) 2008, due to the housing crisis/great recession. Rates didn’t rise again until 2015, with the most significant and frequent bumps happening in 2018. It’s been fluctuating within 1.75%-2.5% during 2018-2019. If you’re interested, you can see a chart of all Fed fund rate changes here.
The big question: will a Fed funds rate hike (or decrease) affect how much home you can afford to buy?
How Rates Impact Home Loan Affordability
Let’s start by talking loan basics. When you purchase a loan product, it’s likely that the interest will be amortized over the entire life of the loan. Basically, this means a higher percentage of your monthly payment goes to interest during the first portion of your loan term. That tends to result in lower home equity in the early years of a mortgage.
Home equity = Value of home minus balance of all liens on property.
Here’s an example:
On a $200,000 mortgage loan at 4.5% APR over 30 years, your initial payments (Principal + Interest) are around $1000/month. 75% of this payment is going towards interest at the beginning, and the total interest paid over the life of the loan would be approximately $165,000.
With the same loan and same term at a lower rate - say around 3.5% you’re looking at an $836 monthly principal + interest payment, with only 65% of that going towards interest, and $40,000 less interest paid over the life of the loan! So yes, even a 1% rate difference matters. Check out this amortization calculator if you want to run the numbers yourself. In the meantime, let’s take a closer look at what impacts mortgage rates.
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What Impacts Home Loan Interest Rates?
Inflation:When inflation goes up, home loan rates tend to go up.
Even a modest uptick in the overall cost of goods and services has a ripple effect on other aspects of the economy. Lending institutions track inflation carefully. Interest rates tend to keep pace with inflation in order for institutions to remain financially stable.
Economic Growth:When GDP (the country’s gross domestic product) and Employment Rates are both up, home loan rates tend to go up.
When these two indirect forces are robust (GDP and employment) it informs lenders to anticipate an increase in demand for loan products. That’s when it makes sense for lenders to charge higher rates for their limited supply of mortgage loans.
Bond Market:As U.S. Treasury note rates rise, mortgage rates go up. Why? They’re competing for the same type of investor (you!). Buyers of both want a low risk and stable return.
Housing Market (a.k.a. the surprisingly sunny side of rising rates):The state of the housing market can impact mortgage interest rates as well. Clearly, a higher rate will cost more than a lower rate over time. But an uptick in rates can have other (beneficial!) consequences due to the so-called rate/home price paradox:
When there aren’t that many homes on the market, but many buyers want them, sellers often increase listing prices. But this usually corresponds with lower rates! You can enjoy a lower monthly premium and quicker impact on the principal due to that low rate.
On the other hand, when there are lots of homes on the market, and less people ready to buy, prices of homes tend to be lower. Interest rates may be higher, but this could still offer a unique benefit - you may be able to shorten your term and pay less interest overall because of the lower principal amount of the loan.
What’s a Home Loan Shopper To Do?
Ups and downs on mortgage rates are neither a new phenomenon nor likely to stop anytime soon. Here are strategies to consider while looking for your dream home:
Shop Around for Lenders
Shop around for competitive rates and for lenders who offer low or no origination fees. Origination fees average around 0.5% to 1% of the home’s purchase price. So for a $250,000 loan, you could save $2,500 by going with a lender that offers no origination fees.
- Lock In Your Rate
When possible, make an agreement with your lender that guarantees you a specific mortgage rate, as long as you commit to close on the property within a specified time frame.
- Adjust Term and/or Price Range
Look at different term options or make adjustments to your home loan price range. You might be surprised to discover what’s possible while staying within your budget. Experiment with calculators like this one to see if shortening or extending the home loan term helps you meet your goals. Financially savvy folks tend to follow the 25% rule when making final decisions in this area – they try to keep their mortgage payment (PITI) under 25% of their monthly income.
When you consider mortgage interest rates within the context of all other factors, it’s easy to see that they don’t present a significant obstacle to you when looking for a home loan. Happy home buying!
This article is intended to be a general resource only and is not intended to be nor does it constitute legal advice. Any recommendations are based on opinion only.
Rates, terms and conditions are subject to change and may vary based on creditworthiness, qualifications, and collateral conditions. All loans subject to approval.