How do Interest Rates Work?
Interest rates are impacted by a borrower’s credit score, loan term, mortgage program and a series of market factors that are outside of the lenders’ control. Unfortunately, many advertisers will tease a low interest rate in a marketing campaign for the purpose of creating interest in a specific loan program which may only fit a unique type of qualified borrower. However, by promoting a lower note rate, with a higher APR, lenders are able to control the flow of the inbound phone call or Internet lead. Understanding how interest rates work will certainly help relieve a lot of unnecessary anxiety about the home financing process.
Key Factors That Influence Mortgage Rates
Timing the market for the best possible opportunity to lock a mortgage rate on a new loan is certainly a challenge, even for the professionals. While there are several generic interest rate trend indicators online, the difference between what’s advertised and actually attainable can be influenced at any given moment by at least 50 different variables in the market, and with each individual loan approval scenario. Outside of the borrower’s control, the mortgage rate marketplace is a dynamic, volatile, living and breathing animal.
As inflation increases, or as the expectation of future inflation increases, rates will push higher. The contrary is also true; when inflation declines, rates decrease. Famous economist Milton Friedman said “inflation is always and everywhere a monetary phenomenon.” Public enemy #1 of all fixed income investments, inflation and the expectation of future inflation is a key indicator of how much investors will pay for mortgage bonds, and therefore how high or low current mortgage rates will be in the open market.
02. The Federal Reserve
The Federal Reserve is responsible for setting the target interest rate: the rate at which financial institutions can borrow money. The target interest rate essentially acts as the rate upon which all other rates are based. So when the target rate goes up, interest rates that borrowers have to pay in the rest of the economy generally go up too.
Decreasing unemployment will suggest that mortgage rates will rise. Typically, higher unemployment levels tend to result in lower inflation, which makes bonds safer and permits higher bond prices. Every month, the BLS releases the Nonfarm Payrolls (aka The Jobs Report) which tallies the number of jobs created or lost in the preceding month.
GDP, or Gross Domestic Product, is a measure of the economic output of the country. High levels of GDP growth may signal increasing mortgage rates. The Federal Reserve slashes short-term rates when GDP slows to encourage people and businesses to borrow money. When GDP gets too hot, there might be too much money floating around, and inflation usually picks up. So high GDP ratings warn the market that interest rates will rise to keep inflation concerns in balance.
Unforeseen events related to global conflict, political events, and natural disasters will tend to lower mortgage rates. Anything that the markets didn’t see coming causes uncertainty and panic. And when markets panic, money generally moves to stable investments (bonds), which brings rates lower. Mortgage bonds pick up some of that momentum. Acts of terrorism, tsunamis, earthquakes, and recent sovereign debt crises (Dubai, Greece) are all examples.
Mortgage Rates FAQs
Why do rates differ so much?
Different lenders have access to different rates, certain mortgage programs offer certain rates, and some people quality for rates that others don’t. It all depends on your lender and your unique financial situation.
What’s the difference between note rate and APR?
Low rates with a high APR may or may not be the best deal.Comparing apples to apples is the best way to determine which loan closing cost and rate scenario makes sense for your short and long-term financial goals.
How do mortgage rates move when The Fed lowers rates?
The traditional news media generally announces mortgage rate movement a few days too late, or when rates are moving in the opposite direction of where we need them to go. One of the biggest misconceptions most people have about mortgage rates is that the Fed, and / or Federal Government control what mortgage rates look like every day.
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