Effects of Mortgage Interest Rates on Home Buying

Those considering buying a home are always interested in interest rates because this will affect the total price of the home and the monthly mortgage payment. Mortgage rates change quite frequently, going up and down on a regular basis. Homebuyers should follow mortgage interest rates and buy when mortgage rates are down. It’s difficult to understand what affects mortgage interest rates and why they fluctuate. Nevertheless, it is important to have a good understanding of mortgage rate basics.

The Basics

The lender of mortgage rates is the originator of the loan and this is most frequently a financial institution of some type. When a mortgage is approved and funded the borrower, you, are given the money. Then, you turnaround and pay the seller of the home the money. What is leftover is your mortgage, what you owe the bank.

Interestingly, the financial institution that funded your mortgage is not stuck with it. They may choose to keep it or sell it. When the originator of the loan keeps it in their portfolio the money you pay each month pays for the interest on the loan and the bank makes money this way. If they sell the loan, then they have more funds in their control to make more loans with. It may not seem like it, but this buying and selling of mortgages affect mortgage interest rates.

Who Affects Mortgage Interest Rates?

Many people have heard a lot about Fannie Mae and Freddie Mac recently. They are government-chartered companies that may buy up mortgages as secondary market investors. Their good business practices or lack thereof, trickles over into the overall market and affects interest rates. Pension funds, securities dealers, and even insurance companies are part of the secondary market and able to buy up mortgages. These investments are liquid and are bought and sold quickly and easily, in most cases.

Now, the details of how the secondary market will affect you as a potential homebuyer. The investors in the secondary market want to make as much money on their investment as they can, which is why they are in business in the first place. The amount of return on their investment is completely dependent on the status of the economy and the perceived status of the future of the economy. When the economy is doing extremely well then returns in the future are anticipated to be higher than current returns. When this happens most investors choose to wait until the higher yields exist to make purchase. When this happens mortgage rates increase because lenders are unable to sell their loans for lower returns.

When the economy is not doing well, even in a recession, investors are anxious to buy the loans that are available to avoid the loans that are available with lower yields in the future. Since investors are trying to buy everything before yields drop, interest rates go down. This is the time when potential homeowners want to buy a home because it can save you thousands of dollars over the life of your loan.

Fixed or Adjustable: A Mortgage Loan Dilemma

Let’s clear the air: Adjustable rate mortgages are not bad. Yes, they’ve gotten a “bad rap” over the last year because people tend to associate adjustable rate mortgages with recent housing woes plaguing the nation but the loans are not the cause of the nation’s real estate crisis; misunderstanding and misusing them is. The reality is that adjustable rate mortgages can, in fact, be an excellent mortgage loan option IF you fully understand how they work. So, with that said, it’s time to learn.

Who is eligible for an adjustable rate mortgage? As with any mortgage loan, anyone can apply. However, adjustable rate mortgages do tend to be more appealing to those who deal with budgeting changes well and those who don’t plan on living in a specific house for more than three to five years. Why? Keep reading…

What exactly is an adjustable rate mortgage? An adjustable rate mortgage is one of the two most popular mortgage loan types offered in the United States. As the name suggests, the mortgage loans are called adjustable because the rate of the mortgage loan changes periodically—most commonly every six months. Mortgage loan firms often abbreviate “adjustable rate mortgage” with “ARM.”

How do adjustable rate mortgages work? The process for obtaining an adjustable rate mortgage is the same as any other loan type. You must apply for a mortgage loan and then, based on your credit standing, a mortgage loan officer will process your information to determine which lenders are willing to fund your mortgage. In most cases, loan officers will present you with multiple home loan options—ARM and fixed-rate mortgages.

Why do people choose the adjustable rate mortgage loan type? The simple answer: The numbers associated with ARMS always look great! In fact, they’re nearly too good to be true…but they are true. The interest rates are low and the monthly mortgage payments are manageable for a much larger percentage of the population than fixed rate loans.

When is an adjustable rate mortgage a good idea? Typically, adjustable rate mortgage loans are best for homebuyers who plan on living in a home for just a few years. The reason: Most ARMs are for 5-years or less; after that time, the ARM typically converts to a higher interest fixed-rate mortgage loan. ARMs can also be a good alternative for real estate investors who cannot obtain an interest only loan for an investment property.

Though anyone can apply for an adjustable rate mortgage loan, whether it’s the best type of loan is completely dependent upon the homebuyer. That’s because the continuous changing of the mortgage interest rates and subsequently, the mortgage payments can be a financial stress for some homebuyers. The ARM becomes even more of a stressor once the ARM matures and the mortgage loan interest rate spikes.

So, what’s the alternative to an adjustable rate mortgage? A fixed rate mortgage of course.

Like adjustable rate mortgages, the name says it all for fixed rate mortgages. Fixed rate mortgages maintain the same interest rate through the life of the loan and therefore, the same mortgage payments. However, there is a tradeoff for that predictability: higher interest rates. That’s why those who plan to stay in a particular home for three or more years often prefer fixed rate mortgage loans.

In the end, the key to determining which type of loan is best—fixed or adjustable—is about mathematics and lifestyle. If you’re on a limited budget but expect your income to increase substantially in each of the upcoming years, an adjustable rate mortgage may be the best option for getting you into a home sooner rather than later. However, if you’re uncertain about if or how your income will fluctuate, it’s best to play it safe and opt for a fixed rate loan. That way, your mortgage payment won’t be a surprise, regardless of what the economy is doing. Of course, if you base your home mortgage loan choice on a mortgage payment that you can afford comfortably based on your current financial situation versus trying to “figure out how to make things work,” either type of loan will have you in your dream home in no time.