Achieving home ownership is a huge thing. People can spend a good part of their lives daydreaming about their forever home. Most people work hard, get a good job, start a family, buy a house, buy a bigger house, accumulate wealth and then pass that wealth to their children.
For those who are new to this, they often wonder “What is A Mortgage anyways?” Don’t worry this first time home buyers guide will walk you step by step through the process of understanding a mortgage and how they work.
If you are thinking of buying a home, there’s a good chance that you’re planning to take out a mortgage to finance this purchase. For newbies,
What is a mortgage rate?
Mortgage rates can be pretty complex, the reason being there are several factors involved in determining rates. You can’t expect to find a mortgage rate using only one financial institution due to the economic variables that come into play.
Even the savviest of mortgage shoppers find it difficult to understand how interest rates are determined.
Let’s begin with some of the basics. What is a mortgage? A mortgage is the term used when you take out a loan to purchase a home. A mortgage rate is interest on the loan that you are taking out. The simplest way to understand mortgage rates is when the economy is strong, you will find that rates are higher.
As mentioned above there are several variables that affect interest rates, however, these are 3 of the most important ones.
- The Federal Reserve-Federal reserve affects variable interest rates-ARM
- Us Treasury Notes and Bonds-Affects fixed interest rates
- Banking industry-Banks offer mortgages and change the interest rates depending on the specific business needs.
US Treasury notes and bonds
In the world of economics, the 10-year treasury note is used to determine fixed interest rates. It is the yield from the treasury that plays a large part in the rise and fall of mortgage rates.
Think of it like this, as bond prices go down, the yield (the rate) goes up. Mortgage rates must rise, or investors would put all their money in the bond market, as opposed to mortgages.
The banking industry is responsible for determining fixed mortgage rates that are in accordance with the central bank. When determining rates the banking industry must take into account competition as well as the market for numerous other interest rates.
Interest rates are one of the primary tools used by central banks to maintain a level of stability within the country’s financial system.
This is a great mortgage calculator for determining current market rates.
What affects mortgage rates?
When you take out a loan, you are taking a risk, but you are not the only one! The lender who gives you the loan is taking a risk by loaning you the money because there is the chance that you may not repay the loan. The lender is also taking a risk with the ups and downs of the economy.
You could be a fiscally responsible adult with fantastic credit. However, if the economy takes a turn and you are laid off from your job you are now a risk to the lender.
The rise and fall of the economy is one of the main reasons you will see rates fluctuate. If banks feel that things are trending in one direction or another their rates will be adjusted to accommodate the swing.
Factors that affect your interest rate
If you’re like most people, you want to find the lowest interest rate possible. Knowing what factors determine your mortgage rate can help you better prepare for the home buying process and for negotiating your loan.
5 factors that affect your interest rate
- Economy– Drives mortgage rates up and down.
- Property location– State laws can drive lender costs up or down.
- Home use – Primary residence, vacation home, or rental?
- Loan features – Terms, points, rates, interest-only payments, etc.
- Loan amount – Very high low loan amounts mean higher rates.
If you are a control freak you may be feeling a bit overwhelmed right now because as you can see there are some things that are completely out of your hands when determining rates. But there
4 Factors that affect your interest rate- You do have control over
- Loan-to-value- Your ability to put more money down improves your chances of loan approval, it cuts your loan fees, and gets you a lower mortgage insurance rate if necessary.
- Credit score- The higher your credit score is, the better your chances are of lower interest rates.
- Loan terms- Choosing a loan with a 15-year term instead of a 30-year term can save you a lot in interest.
- Points- You can buy a lower interest rate by paying more upfront. 1 point costs 1% of your mortgage amount ($1,000 for every $100,000)
If you are thinking of buying your first home. You may find this guide super helpful to walk you through the process step by step.
Fixed rate vs. adjustable rate mortgages
When it comes to choosing a loan you have the option between a fixed rate or adjustable rate mortgage. Remember the interest is the “risk” the bank is taking on your behalf. So, unfortunately, there is no way around paying extra interest for the lifetime of the loan.
The main difference between the two is that with a fixed rate you are locked into a guaranteed interest rate for the lifetime of the loan. An adjustable rate is one where the interest may go up or down depending on the economy.
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Adjustable rate mortgage
The smarter choice for some people is an ARM(adjustable rate mortgage). ARMS’s start off at a very low fixed rate for a set number of years and increase from there.
They are typically fixed for 5-7 years before the rate begins to change. ARM’s can be great for people who don’t plan on living in one house for very long because of the lower rate early on.
I’m sure you can see that there are risks that come with having an ARM. After the fixed rate period is over the rate can increase and you could find that your payments are more than you bargained for.
Typically, there are caps on how much your payments can increase, both annually and over the lifetime of the loan. Make sure to read the fine details in the truth in lending disclosure.
Fixed rate loans are the loan of choice for many people due to the predictability. These loans, represent over 75% of all home loans. People like to know how much they have to set aside each month and they are comfortable knowing they will not have to pay any more than the amount that was decided upon.
Another good thing with a fixed rate is that if interest rates rise you don’t have to worry about your payment increasing.
30-year vs. 15-year Mortgages
The 30-year mortgage has been the U.S. standard for several years, but it’s not the only option. 15-year mortgages generally have lower rates and allow you to pay off your home quicker.
The most obvious advantage of a 15-year mortgage is that you’ll pay off your home in half the time it would take with a 30-year mortgage.
Shorter loans will have larger monthly payments that are offset by lower interest rates and lower overall cost.
Example – A $200,000 fixed-rate mortgage for 15 years (180 monthly payments) at an annual interest rate of 4.0% will have a monthly payment of approximately $1,479.
The obvious reason to choose a 30-year mortgage is that it allows you to buy a home and pay less per month than you would with a 15-year mortgage.
A couple of the disadvantages are you will have a higher rate because the bank is lending you money for a longer period of time. You will also be paying a much higher total cost due to the length of the loan.
Example – A $200,000 fixed-rate mortgage for 30 years (360 monthly payments) at an annual interest rate of 4.5% will have a monthly payment of approximately $1,013.
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Saving a fraction of a percent on your interest rate can save you thousands of dollars over the life of your loan, so it definitely pays to prepare, shop, and compare offers.
Nobody want to buy a house and figure out it’s a house they can’t afford.
By educating yourself about what a mortgage is it will enable you to feel confident when speaking with lenders, asking questions, and you will have a better understanding of your loan choices. Interest rates fluctuate daily so it makes sense to gain awareness about what is typical.
By knowing the range of rates you will feel more comfortable locking in a rate and you will know when it is time for you to shop around for a better rate.