To some, the interest rate is a rather meaningless number that seems to change on an almost daily basis. However, if you are applying for a credit card, buying a new car or applying for a mortgage, this number can significantly affect how much you are paying every month and over the term, or length of your loan. At the time of writing, mortgage rates are low and it is a good time to buy a home, or refinance an existing mortgage at a lower rate.
The interest rate is defined as the amount of money it will cost you to borrow a certain amount of money from a bank or lender. It is virtually impossible to accurately predict mortgage interest rates; one of the biggest factors that influence them is simple supply and demand. If more people are buying houses, more money is being borrowed, which means that lenders can charge higher rates to borrow the money. In a slow economy, less people are borrowing money, rates are generally lower to attract customers, and there is more money to lend.
The mortgage interest rate affects you both in the short term and the long term. A rate that is lower means that your monthly payments are lower; it also means that over the term of the mortgage, you are paying less. Whereas the traditional mortgage is taken out for a period of 30 years, a lower rate means that you may perhaps be able to take out a shorter term mortgage, of 20 or even 15 years. Also, it means that you will own your home outright, sooner rather than later – a big advantage.
The total amount that you will end up paying for your home can potentially vary a great deal with even just a small change in the interest rate. A reduction in the interest rate of just one point can mean that a homeowner with a traditional 30 year mortgage can enjoy average savings of around $50,000 over the term of their mortgage. And a small increase in the interest rate of just one or two percent can result in monthly payments that are anywhere between $50 and $250 higher, depending on how much your home cost to begin with.
When it comes to buying a home and taking out a mortgage, you basically have two options – a fixed rate mortgage (FRM) or adjustable rate mortgage (ARM). An FRM is the safer and more stable option – the interest rate on the loan doesn’t change, regardless of whether interest rates in general go up or down. The obvious disadvantage of an FRM is that the interest rate may be lowered; resulting in you making higher monthly payments than you would otherwise be doing, unless you refinance. It’s estimated that around 70% of all homebuyers today take out a fixed rate mortgage, rather than go with the riskier adjustable mortgage.
If you have an FRM at a higher interest rate and rates go lower, your only option to take advantage of the lower rate is to refinance. Some financial experts will tell you that it is only worthwhile refinancing if the interest rate on your new mortgage will be at least 2% lower than your current rate, although of course the decision whether to refinance or not is up to you. You should also take into account how long you are planning to stay in your current home – if you are planning to move within a year or two, it probably doesn’t pay you to refinance.
An ARM is the riskier of the two options – as the name suggests, the interest rate can vary, depending on the interest rate at the time, meaning that your monthly payments may be higher or lower. If you have a good rate to begin with and you can afford to pay the extra payment should interest rates rise, this may be a good option for you. If an increase in interest rates will hurt you financially – or if you are just the cautious type who doesn’t like to take risks – an ARM loan perhaps isn’t a good idea.
So if you are applying for a mortgage, pay particular attention to the all-important interest rate – it can potentially save you or cost you a lot of money over the next 30 years.
About The Author
Rachel Jackson is a freelance writer who writes about mortgages and home ownership, offering tips such as how to find the lowest mortgage rates.
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