Interest Rates
A good interest rate can make all the difference when it comes to investing in a home. Low interest rates often allow homebuyers to pay off their mortgages more quickly over a shorter period of time because they are manageable, while high interest rates can keep a homebuyer in debt for decades.
By definition an interest rate is the rate of return a lender gets for allowing the borrower to use their money. Interest rates are typically expressed as an annual percentage of the amount loaned and are usually calculated by lenders semi-annually.
All interest rates are directly influenced by the economy in terms of inflation and the principles of supply and demand.
Factors that Directly Affect All Interest Rates:
- Supply and demand
- Consumer Price Index
- Gross Domestic Product
- Employment Cost Index
Like anything else when there is a substantial demand for loans and mortgages interest rates will increase. Conversely, if there is a reduced demand interest rates will mirror this and will be reduced as well. When there is demand for resources, monetary or otherwise, those who have them seize the opportunity to charge extra for what they have.
Because interest rates are influenced by inflation the Consumer Price Index (CPI) also has an affect on how much homebuyers will end up paying when it comes to their mortgages. The Consumer Price Index or CPI is updated every month and measures the prices of consumer goods and services. It is used to determine the pace of U.S. inflation.
Gross Domestic Product (GDP) is considered by many to be the most important measure of U.S. economic performance so it obviously influences whether interest rates will be high or low. GDP is calculated by the U.S. Commerce Department every quarter to indicate the total market value of all goods and services, including consumer and government purchases, private domestic investments and net exports of goods and services, in the U.S.
When the GDP indicates that economic growth is strong sometimes the demand for goods and services can exceed the supply of goods and services. In response to this businesses, including lenders, tend to charge more.
The Employment Cost Index also plays into the how interest rates are calculated. The Employment Cost Index defines the rate of fluctuation in wages, salaries and benefits. High labor costs can force companies, including banks and other financial institutions, to raise prices for their services.
The best interest rates are typically available when the economy slows down. This is usually occurs because when the economy is slow the Federal Reserve is known to cut interest rates to help it improve. During this period lenders are able to offer lower mortgage rates to consumers.
Affects On Interest Rates
Though interest rates are largely affected by economic conditions, each borrower's financial situation can also influence the individual rate they are offered by their lender.
Other Factors that can Affect the Mortgage Interest Rate a Homeowner is Offered:
- Amount of mortgage down payment
- Length of mortgage
- Risk the borrower poses to the lender
- Whether the loan is a first or second mortgage
Most mortgages require that the borrower put down 20% of the purchase price of a home as a down payment, but there are alternatives for people who may not have enough cash saved up to fork over 20%. A borrower who can't afford to make a huge down payment can accept mortgage insurance but if they aren't approved for this or don't accept it they can might have the option of accepting a mortgage with a high interest rate to compensate the lender for the lack of down payment.
The length of the mortgage, or the amortization period, will also contribute to the interest rate each homebuyer is offered. Depending on a borrower's financial situation the lender will typically assess the amount of time the borrower will take to pay back their debt. Lenders generally feel that there is more financial uncertainty associated with borrowers who require long-duration loans as opposed to those who are eligible for short-duration loans. Over long periods of time problems could arise with a borrower's financial stability so when lenders commit to a long haul, they usually expect to be compensated for it.
In most situations the worse a person's credit history is the less potential that person will have to get a conventional mortgage with reasonable interest rates. Often people with bad credit histories are turned down for mortgages and other loans all together because they pose too much risk to lenders, but there are certain exceptions to this rule. Some lenders offer bad credit mortgages to people who have unsavory credit histories, but who appear to be back on track paying bills off on time and maintaining credit responsibly. These bad credit mortgages don't come without a price though. Lenders who offer these sorts of plans need to make sure that they cover their backs so almost every bad credit mortgage will have interest rates higher than conventional mortgages to compensate the lender for the risk they are taking.
Second mortgages also typically have higher than average interest rates. Again, this is because second mortgages pose a substantial risk to the lenders that offer them. This is because if a property goes into foreclosure, the first mortgage must be paid in full before the second mortgage holder can be paid. In other words if there are two mortgages and a property is sold, the proceeds from the sale will be claimed to pay off a first mortgage if there is still money owing to this lender. After the first lender is paid there may be no money left to pay the second lender.
Generally if a homeowner has good credit and is able to put down a substantial down payment they will be offered the opportunity to take a risk of their own when it comes to interest rates.
Interest rates often influence whether borrowers will opt for fixed or adjustable-rate mortgages and each plan has both negative and positive attributes.
With a fixed-rate mortgage the interest rate is guaranteed to remain consistent throughout the duration of the mortgage so people with this sort of mortgage rate plan will always pay the same amount. When interest rates are low most people find it more beneficial to opt for a fixed-rate mortgage because by choosing this sort of plan they are assured a low rate for the duration of your mortgage.
Purchasing an adjustable-rate mortgage is more of a gamble. As mortgage rates continue to fluctuate, so does the amount that you will pay from month to month with an adjustable-rate mortgage. If mortgage rates happen to be high most borrowers find they are better off purchasing an adjustable-rate mortgage because of the lower initial rates and the prospect of being able to take advantage of falling interest rates that may occur in the future.
As a homeowner interest rates can make or break you. People with good credit who take advantage of low rates when they come around could sail through mortgage payments with ease while others who have below average credit may get stuck paying exorbitant rates for years.
To avoid paying through the nose for a new dream home every homebuyer should take an interest in learning about interest.
