Mortgage Interest Rates

Besides the purchase price of your home, your mortgage interest rate is the most important factor determining how much your monthly payments will be. Understanding how these rates are determined, and what you can do about it, can save you thousands of dollars over the life of your mortgage.

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Although you’ll accept a mortgage through a local bank or lender, those companies don’t have much to do with setting your mortgage interest rate. Most of the determining factors about mortgage rates come from New York’s Federal Reserve Bank. As the Federal Reserve adjusts their funds rate, banks interest rates also change. Many mortgage lenders watch the interest on ten-year bonds, believing that this is an accurate reflection of the economy. When the yield on the ten-year bond changes, so do mortgage interest rates.

Recently, mortgages have been at their lowest in decades, but they are slowly starting to rise. A 30-year fixed mortgage in March 2006 had an average interest rate of 6.35 percent, up from 5.55 percent in July 2005, but this increase still makes mortgages a bargain compared to interest rates from the early 1980s which hovered in the 16 percent range for years.

What does this rate change mean to the average home buyer? Depending on a number of other factors, such as closing costs and your down payment, increasing mortgage rates could mean you’ll pay a few hundred dollars more a month.

Let’s take a look at how rising interest rates affect monthly payments on a $200,000 house. We’ll assume the homebuyer paid 20 percent of the house cost in their down payment, making the amount of the 30-year fixed rate mortgage $160,000. In March 2006, the monthly mortgage payment would be $1,120.02. The same mortgage that was entered into in July 2005 would see payments of $1,027.67. If that extra $92.35 a month startle you, imagine paying $2,420.56 a month, as you would have under the 1980 rate.

Keep in mind that the mortgage interest rate is different from the annual percentage rate (APR). The APR is the annual cost of your loan and figures in extra costs like fees and insurance. The APR will usually be slightly higher than the interest rate.

Lenders look at your overall ability as a homebuyer to decide your interest rate. If mortgage interest rates are low but you have bad credit, you’re rate will be higher. Maintaining good credit and employment histories are key in keeping your rate down.

There are several types of mortgages that are based on the length of the loan and how interest is computed. The most popular include:

• Fixed Rate Mortgages: As the name implies, fixed rate mortgage interest rates and payments remain the same over the life of the loan. If you accept a mortgage at 6 percent and the market pushes rates up to 11 percent, your monthly payment stays the same.
• Adjustable Rate Mortgages: Monthly payments for adjustable rate mortgages change based on the interest rates. These often have a ceiling that prevents the payments from going above a certain amount.
• Subprime Mortgages: These are reserved for people with poor or no credit history and carry much higher mortgage interest rates.

In some cases, you may benefit from paying points on your mortgage. This allows you to lower your mortgage interest rate by paying a fee. Each point costs one percent of the total loan and is paid at closing.

Using our earlier example, paying two points on a $160,000 mortgage would cost $3,600 at closing but would lower your interest. In this case, the two points would change your monthly payment from $1,120.02 to $1,096.61, a savings of $23.41 a month. But, you’ll lose money if you don’t stay in the home for at least 12.7 years, the amount of time it would take to recoup your initial $3,600 cost for the points.

Deciding whether or not to buy points depends on how much money you have to spend on points and the amount of time you’ll be in your home. If mortgage interest rates are high, you could save money over the course of the loan by buying points.

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