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How Do Mortgage Rates Work?

imgresThe bank of the U.S., the Federal Reserve, first sets one main rate called the Federal Funds Rate.  The Federal Funds Rate affects other aspects of the economy and business, not just the mortgage industry.  For example, the Federal Funds rate effects the discount rate and the prime rate.

What is a Discount Rate?  A discount rate is the interest rate at which businesses (particularly commercial banks and other institutions for loans) can borrow money from the Federal Reserve in the case of an emergency.  This rate is calculated based on the current value of money as well as the risk associated with cash flows.

What is the Prime Rate?   A prime rate is the interest rate that a commercial bank charges their clients with favorable credit.  The prime rate is determined by the Federal Funds Rate, or the interest rate at which commercial banks lend to each other overnight, set by the Federal Reserve.  A bank with an excess of funds charges an interest rate to another back that needs a loan of funds.  The Federal Reserve can change the Federal Funds Rate up to eight times per year.  The prime rate also affects retail customers as it affects the lending rates available for mortgages.  It impacts interest rates on short-term debts such as credit cards and long-term debts as well such as mortgages.

With all of that being said, the Federal Reserve is not the only factor that plays into determining home mortgage interest rates.  But, if it is not just the Federal Reserve, then who else factors into the equation? The answer is: each and every one of us.  The more that people spend money, the more money that is available in the economy, which in turn increases interest rates as there is a surplus of money.  On the other hand, when money is scarce, less people are spending money, thus leaving less cash available in the economy and making interest rates lower.

Even though the Fed’s interest rates are not necessarily mortgage interest rates specifically, mortgage interest rates for the most part still directly correlate with the interest rates set by the Fed.  To encourage people to purchase mortgages, the Fed also buys treasuries or securities to lower interest rates.  This changes mortgage rates as treasuries and securities are backed by mortgages.

So How Does the Mortgage Firm Determine My Interest Rate?

If you have ever shopped around for mortgage rates, it doesn’t take more than two phone calls or clicks to figure out that #1: rates are constantly changing, and #2: there is no ‘one interest rate’ at any given time.  One can understand the reasoning behind the former.  But, in terms of the latter, we ask, “why is there no ‘one interest rate’ at any given time?”.  To answer that question, well: there is no ‘one given answer.’  There are quite a few things that factor into an individual’s mortgage rate, and everyone gets something different.

  • The Amount That You Put Down for Your Down Payment – The more that you put down for your down payment on your mortgage, the better that your interest rate will be.  The same goes for the amount that you put down towards closing costs.  The key is to save as much as possible before buying a home.
  • The Type of Loan that You Apply For – Each type of loan has different terms and conditions.  It is best to go over the loan types with an experienced loan officer who can explain to you your options and help determine which type of loan is best for you and your family.  It is also important to pay attention to whether the interest rate is fixed or variable.  A fixed interest rate is one that remains the same for the life of your loan, and a variable interest rate is one that fluctuates with the market.
  • Credit Score – More often than not, those with excellent credit scores receive the best mortgage rates.  Excellent credit scores are seen by mortgage lenders as 740 and above.  It may be in your best interest to clean up your credit before getting tied up in a mortgage.  Your bank account will thank you for the next 30 years or so.
  • Points Purchased – Buying a point on your mortgage is a method of saving money in the long term.  It is a pre-paid interest on your mortgage.  On average, each point shaves ¼ or a percent off of your interest rate.  The cost of a point is 1% of the total amount, so for example: a loan of $200,000 would have each point cost $2,000.  It can save thousands of dollars over the loan term that would have otherwise been down the drain lost to interest.  At the right time during your loan, points will lower your overall mortgage payments per month.

 

If you have any questions about the information herein, feel free to reach out to the Author, Brittany Williams, at Brittany.williams@broadviewmortgage.com.  If you would like a quick preapproval Click Here, and for assistance with down payment or buyer assistance Click Here.  You are also always free to give us a call Toll Free (855) 692-7623.

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