Interest rates play a fundamental role in the world of mortgages. They determine the cost of borrowing and significantly influence the affordability of homeownership. In this blog we will explain how interest rates work, factors influencing them, and how they affect monthly payments and the overall cost of a mortgage. Of course, for more information, our team of Bank Five Nine Mortgage Lenders are always here to help answer any questions you may have.
Understanding Interest Rates
At its core, an interest rate is the cost of borrowing money. When you take out a mortgage, you’re essentially borrowing a substantial sum of money to purchase a home, and you are charged with interest for the privilege of accessing those funds. This interest is a percentage of the loan amount and is paid back over the life of the loan, which can typically range from 15 to 30 years or more.
When interest rates drop, housing prices often tend to go up and when interest rates are low, it becomes cheaper for people to borrow money to buy homes.
- When interest rates are low, generally more people can afford to purchase houses, increasing the demand for homes. As demand rises, sellers can ask for higher prices since there are more buyers willing to pay.
- When interest rates rise, borrowing money for a home becomes more expensive. This can lead to fewer people being able to buy homes, causing the housing demand to go down. When demand goes down, sellers might need to lower their prices to attract buyers.
Factors Influencing Interest Rates
- Economy: During periods of economic growth, interest rates tend to rise as demand for credit increases. During economic downturns, interest rates often decrease to encourage borrowing.
- Federal Reserve: The actions of the Federal Reserve in the United States, have a significant impact on interest rates. They use policy tools to influence the economy and may raise or lower interest rates to control inflation and economic growth.
Here’s how it works: when the economy is speeding along too quickly and things are getting expensive too fast (that’s inflation, which we will talk about below), the Federal Reserve might make borrowing money a bit more expensive (meaning interests rates go up). This can help slow down spending and keep prices in check. On the flip side, when the economy is slow-moving. they might lower the cost of borrowing money (meaning interests rates go down). This encourages people to spend more, which can help the economy grow. - Inflation: Inflation is when things get more expensive, and your money can’t buy as much as it used to. To make sure the money they lend does not lose its value, lenders can raise the interest rates a bit when they think prices are going to go up. This helps them keep the money they lend worth the same, even if stuff gets pricier.
- Credit Risk: Your “creditworthiness” as a borrower also affects your interest rate. Individuals with higher credit scores are seen as lower-risk borrowers and may qualify for lower interest rates, while those with lower scores may face higher rates. If you are someone who’s really good at paying back what you owe, lenders trust you more. They see you as a responsible borrower and might give you a lower interest rate. But if you have had trouble paying bills on time or managing your money, lenders might think you’re riskier, so they may charge a higher interest rate to make sure they’re covered if you can’t pay back on time.
Here are some blogs about credit:
- 7 of the Best Ways to Improve Your Credit Score
- How to Improve Your Credit Score
- What You Should Know About Credit
Impact on Monthly Payments and Overall Mortgage Cost
- Monthly Payments: The interest rate decides how much you pay every month for your mortgage. If the rate is higher, you will have to pay more each month. But if it is lower, your payments will be more affordable. At the beginning of your loan, a bigger part of your payment goes to interest.
- Total Mortgage Cost: While you are paying off your mortgage, the interest you pay can become much bigger than the actual amount you borrowed. A high interest rate means you pay more in total, making the loan cost more. A low interest rate can save you a lot of money over the whole time you’re paying back the loan.
At Bank Five Nine, our Mortgage Lenders are always here to help you make sense of all things mortgage, guiding you toward the best practical mortgage options for your particular situation.
Find a Bank Five Nine Mortgage Lender here: www.bankfivenine.com/mortgage
Sources:
https://www.federalreserve.gov/faqs/why-do-interest-rates-matter.htm
The Fed – What is inflation and how does the Federal Reserve evaluate changes in the rate of inflation?
