By A Home in Seattle
The vast majority of us don't pluck a wad of cash from thin air to purchase our dream homes. Instead, we navigate the complex world of mortgages. Central to this financial journey is the concept of mortgage interest rates, a topic often shrouded in mystery. In this blog post, we'll unravel the intricacies of mortgage interest rates, explaining how they work, how they are determined, and why this all matters to prospective homeowners.
What Are Mortgage Interest Rates?
At its core, a mortgage is a loan secured by real estate. When we talk about mortgage interest rates, we're referring to the cost of borrowing money from a lender to purchase a home. In simpler terms, it's the fee you pay for the privilege of borrowing the funds necessary to turn the key in your front door.
Understanding the mechanics of interest rates involves grasping two fundamental components: the principal amount borrowed and the interest charged by the lender. Let's break it down:
Principal Amount: This is the total amount borrowed to purchase the home. As you make payments, a portion of your payment goes toward reducing the principal, or the lump sum borrowed.
Interest: This is the cost of borrowing the money, expressed as a percentage. Interest payments are in addition to repaying the principal and constitute the profit for the lender. Historically, mortgage rates have been anywhere from 2.65% (January 2021) to 18.45% (June 1981).
Monthly mortgage payments typically include both principal and interest, creating a balance between repaying the borrowed amount and compensating the lender for their services.
Who sets mortgage rates?
The Federal Reserve, often referred to as the Fed, influences mortgage rates through its control over the federal funds rate. This key interest rate serves as a benchmark for many other interest rates, including those on mortgages. When the Fed raises or lowers the federal funds rate, it directly impacts the cost of borrowing money for banks. If the Fed raises the rate, banks may increase mortgage rates to maintain profitability. Conversely, if the Fed lowers the rate, banks might reduce mortgage rates to encourage borrowing. The actions of the Federal Reserve have a ripple effect on interest rates, ultimately shaping the affordability of mortgages for homebuyers.
How is my personal interest rate determined?
While it might seem like lenders pull rates out of thin air, there's a method to the madness. The rate you are offered is dependent on the federal funds rate at that moment, along with factors in your personal financial situation. Here are some key influencers:
- Creditworthiness: Your credit score is a crucial factor. A higher credit score signals to lenders that you're a lower-risk borrower, often resulting in more favorable interest rates.
- Debt-to-Income Ratio: One factor in creditworthiness is your Debt-to-Income ratio. This is how much debt you have in relation to your income. A lower DTI suggests more financial flexibility, while a higher DTI may raise concerns about the ability to manage additional debt.
- Loan-to-Value Ratio: Lenders assess the ratio of the loan amount to the appraised value of the property. A lower LTV ratio often leads to better rates, as it signifies a lower risk for the lender.
- Type of Loan: Fixed-rate and adjustable-rate mortgages come with different risk profiles. Fixed-rate mortgages are considered less risky, offering stability over time, while adjustable-rate mortgages carry an element of uncertainty, potentially impacting the interest rate.
So, why does this all matter?
Your interest rate affects the size of your monthly payment. Compare a $700,000 home purchase at the historically lowest rate vs. the historically highest rate. Let’s assume a 20% down payment of $140,000, which makes the loan amount $560,000.
$560,000 loan at 2.65% = $2,681.60/month payment
$560,000 loan at 18.45% = $8,645.58/month payment
As you can see, rates can mean the difference between affording a home, and not affording a home. We love using mortgagecalculator.org to play with different price points and see how today’s interest rates affect our clients’ monthly payments.
How to choose a lender?
Well, that’s a blog post for another day, but for now we will just drop a link to our favorite lender here in Seattle. The team at A Home in Seattle has our personal loans with Julie Johnson at CrossCountry Mortgage, and she has helped countless of our clients get into their forever homes.
Reach the A Home in Seattle team anytime at alexanderkeyes@ahomeinseattle.com or by scheduling a meeting.
