How Do Mortgage Interest Rates Work?

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Interest rates have been a hot topic of conversation lately, with recent headlines reporting rising mortgage rates. Not surprisingly, it’s left many wondering how mortgage interest rates work and what it means for them.

What are interest rates, and why do they matter to you?

An interest rate is the percentage of principal charged by the lender for the use of its money. The principal is the amount of money loaned. The interest rate on a loan is typically noted annually, known as the annual percentage rate (APR). There are two kinds of interest: simple and compound.

The difference between simple interest and compound interest is the way the interest accumulates. Simple interest accumulates only on the principal balance, while compound interest accrues to the principal balance and the accumulated interest.

Simple interest works in your favor when you borrow money, while compound interest is better for you as an investor. As a borrower, simple interest is better because you’re not paying interest on interest. It’s easier to repay debt with simple interest. Compound interest can help you to build wealth over time because your earnings also earn money. 

How is simple interest calculated?

Simple interest is calculated, rather simply, on an annual basis as a percentage of the principal amount. You can compute simple interest by multiplying the principal amount by the annual interest rate and the number of years you invest or borrow money.

Simple interest is usually owed on traditional mortgages, car loans, and personal loans. To calculate simple interest, multiply the principal amount by the interest rate and the time.

If you don’t want to do these calculations yourself, you can use a mortgage payment calculator.

What drives mortgage interest rates?

Factors determine interest rates within and outside your control as a consumer and mortgage borrower.

Interest Rate Drivers INSIDE Your Control

Your Credit Score (FICO)
Your credit score can play a key role in the interest rate that you receive. If you have a higher credit score, you may benefit from lower rates, while those with a lower credit score may see higher rates.

Down Payment
If you can make a larger down payment, you may see a reduced interest rate. Mortgage lenders see larger down payments as less of a risk.

Term and Loan Type
The loan term and type of loan you select may also have an impact on your interest rate. For example, if you select an adjustable-rate mortgage (ARM), you may receive a lower initial rate, but it could increase in the future. You may also find that if you are financing a primary residence (meaning a property you intend to occupy as your main residence), you’ll see a lower interest rate since a primary residence is typically seen as less of a risk.


Interest Rate Drivers Outside Of Your Control


Inflation
Inflation is the increase in the price of goods and services over time. Higher and lower inflation rates typically correlate with higher or lower interest rates.

Economic Data
Economic news typically drives changes in interest rates. If the 10-year treasury rises, interest rates will follow suit. If the 10-year treasury lowers, so will interest rates.

Supply and Demand Within the Mortgage Industry
A high demand within the mortgage industry can be a driving force behind rates. If the mortgage industry is busy, rates are often higher.

How do Interest Rates Affect Your Buyer Purchasing Power?
Mortgage rates play a significant role in your home search. As rates go up, your monthly mortgage payment increases if you buy a home, directly affecting how much you can afford. And even the smallest increase can have a large impact on your monthly payment.

Just a short time ago, rates were at 2.9%. Economists predict rates will rise over a half of a percent from where they are now – to 3.5% – so you’re looking at $98 of increased interest on your monthly payment for a $360,000 loan. That’s no small amount; $35,280 in extra interest over the 30-year life of the loan. Add in rising home values and uncertainty around available inventory, and it could be costly to wait.

The important thing is that you stay focused on your goals and communicate with a trustworthy professional who will connect you with the best options.

Are you ready to see what rates are in store for you?

You can use your newfound motivation to energize your search and plan your next steps accordingly so you’re prepared to act no matter what happens with mortgage rates. One way to do that: consider rising rates as part of your budget.  

Danielle Hale, Chief Economist at realtor.com, puts it best, saying:

“Smart buyers should consider calculating a monthly payment not only at today’s rates but also at rates that are a bit higher so that a sudden upward move won’t derail them. . . .”

You should also be ready to act when you find a home that meets your needs. That means getting pre-approved with a loan officer so there won’t be any delays when the time arrives.

Serious buyers should approach rising rates as a motivating factor to buy sooner, not a reason to wait. Waiting will cost you more in the long run. Get started today by applying online or by calling 508-407-8300, so you can better understand your budget and be prepared to buy your home even before rates climb higher.

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