Anyone who pays the slightest attention to financial news has probably heard that interest rates have power to affect the home buying market. The amount of interest that people pay for what is generally the largest loan they will ever take has a significant effect on the loan and borrowers' ability to access it. This guide identifies how interest rates can change a mortgage applicant's buying power, as well as the real estate market at large.
1. How Do Average Mortgage Interest Rates Change?
Like other interest rates, mortgage interest rates tend to go up and down over time. Although changes from one week to the next may seem minimal, after a period of several years, mortgage interest rates may rise or drop significantly. For much of the 2010s, mortgage interest rates hovered around 3.5-4.5 percent. This is a far cry from interest rates ranging from 5.3-6.5 percent in 2008, just before the housing crisis began.
Mortgage interest rates are indexed somewhat to the cost of funds from the Federal Reserve. Banks and other financial organizations may borrow money from the Federal Reserve at a specific interest rate. For a few years, that rate was around 0 percent, leading to a longer period of historically-low mortgage interest rates. A rise in the funds rates correlates to a slight increase in the average interest rates for mortgages.
2. Can Mortgage Applicants Get Different Interest Rates?
Although potential borrowers can easily see the interest rates available for different types of mortgage loans, not everyone will gain access to these rates. As a general rule, the published rates listed on lenders' websites are for people with the highest qualifications. This means that, in order to get these kinds of interest rates, applicants should have:
- credit score above 740
- long credit history
- solid income and employment record
- large down payment
Home buyers should keep in mind that the rates that one lending institution may offer them could vary from other lenders, sometimes by a significant margin. This is why the Consumer Finance Protection Bureau strongly recommends that people apply to more than one lender. That way, they can compare the terms and choose the loan that works best for them.
3. What Effect Does Interest Rate Have on Home Buying Power?
Interest rates' hold on buying power is related largely to the maximum debt-to-income ratio borrowers can have. Lenders want to make sure that a home buyer is not getting into more debt than they can handle. As such, there are industry standards defining a maximum ratio of debt to gross income for the mortgage payment alone, and another ratio for the mortgage payment plus the borrower's other debts.
The monthly mortgage payment contains a payment of principal and interest, which varies based on the interest rate. The higher the interest rate, the higher the payment for the same amount in a loan. An individual's buying power goes up and down with changes in interest rates. People who have a modest income or live in an area with a higher cost of living may find that their buying power is capped because of the interest rate they can secure.
4. How Can Borrowers Decrease Their Mortgage Interest Rates?
Although home buyers' mortgage interest rates are largely based on the rate that a lender is willing to give them, there are a few ways that applicants can change the terms to their favor. First, they should confirm that their application is accurate, showing all valid income and a credit report with no errors. Otherwise, they might consider a different kind of loan with a better interest rate, like a 15-year fixed-rate mortgage instead of a 30-year fixed. They may decide to pay down discount points at closing, which will decrease the interest rate for the duration of the loan.
5. Could Mortgage Interest Rates Affect the Real Estate Market?
The situation of mortgage interest rates can boost or slow the real estate market in any area. Home values are based largely on demand for the homes by qualified Kingstowne buyers. If interest rates go down and more buyers can get mortgages, home prices may go up in desirable neighborhoods. When interest rates start to rise, buyers have a more limited buying power. They may choose to buy in another area, buy a more modest property, or wait until rates go down. In this way, a change in mortgage interest rates of a half percentage point or more could make a down market hot, or a fast market slow.
Getting a mortgage must involve a careful analysis of mortgage interest rates, due to their effect on the mortgage loan and home buying power. By understanding how interest rates can alter a home buyer's prospects, people can better plan for a future as a homeowner.