A lot of people spend a great deal of time trying to figure out how the interest rates are going to look tomorrow, next month or 10 years from now, because these rates can have a huge impact on how much it costs to buy a home. If someone suspects that interest rates are about to spike, they'll want to apply for their loan as quickly as possible to lock in the low rate. If they think it's about to drop, they might hold off on buying or refinancing for now or choose an adjustable rate mortgage to take advantage of falling rates.
While it's impossible to know exactly what interest rates are going to do, understanding what affects them can help you make smarter financial decisions.
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Supply and demand
In a tale as old as time, the economy always comes down to supply and demand. When the economy is struggling, fewer people are interested in or can afford purchasing a new home. So, lenders want to encourage potential borrowers by giving low interest rates. It’s just like when a store discounts its products that aren't selling as well.
However, when the economy is stronger, unemployment is down and many people are ready to go house shopping and are looking for a loan, so lenders can return their rates to a more profitable percentage.
Because of the balance struck between lenders and borrowers, supply and demand keep interest rates moving and adjusting constantly.
The Federal Reserve
During an economic downturn, as was seen during the past several years, the U.S. Federal Reserve steps in to help stimulate the economy. It does this by buying up federal debt, which sends money back into circulation. This supplies banks with more money to be loaned out, thus lowering the interest rates they offer.
So, while the Fed does not have the ability to directly set rates, it can certainly have a huge impact on where these rates are headed. Even rumors that the Fed may rein in a bond-buying program can send interest rates shooting up.
10-year Treasury yield
In an effort to stabilize interest rates, mortgage lenders may tie their current mortgage rates to the 10-year Treasury yield, which is considered a good gauge of how interest rates will look long term. By attaching their rates to a 10-year Treasury bond, lenders can protect themselves against interest rate changes that may hurt their profits.
Investment firms may use government-issued bonds as a product to be sold to investors. These are appealing as they are considered a fixed-income investment. Once a stake in a mortgage is sold, it is called a ‘security,’ and it allows investors to profit on the interest that homeowners are paying each month. Depending on how well the bond market is doing, mortgage securities may become more or less popular, thus changing how much money lenders have available to loan out to borrowers. This in turn affects the mortgage rates.
While this does not have an effect on mortgage rates at large, how strong your credit and financial situations are will have a large impact on the kind of interest rate you will receive. If you have a spotty credit history you are considered a higher-risk borrower, so the lender is going to charge you a higher interest rate. On the other hand, a strong credit history and a solid income will get you a lower rate.
Despite the recent Federal Reserve rate hike, home loan rates are still extremely low but there is no guarantee they will stay that way going forward. If you are considering buying or refinancing, you can discuss your options with a licensed loan officer to make sure you are getting the best deal for your impending purchase.
Published February 5, 2016
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