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The Up and Down of Interest Rates


The housing market is, like stocks, oil, and bonds based on the predictions of the futures market. Because of this, there is typically a vast amount of minute changes will grander changes occur slowly over time. Eventually, an emerging trend breaks which usually reflects the future of the market.

Currently, the trend has been leaning towards a rise in interest rates. Most of the increase comes from speculation that the Federal Reserve was going to slowly stop buying bonds. This fear led to a jump in fixed-rate mortgages – nearly 1.5% in less than half a year. On a $250,000 30-year fixed mortgage, this 1.5% increase would cost homeowners over $200 per month.

interest rates
interest rates

Will Rates Continue To Rise?

The release by the Federal Reserve that they will continue to buy bonds helped to slow the interest rate rise and have slowly begun to reverse. However, economists do not expect the drop to exceed .5%. For the next year, rates are expected to fluctuate around 4.5% with slight gains and drops as can be expected from any volatile market.

Current forecasts, assuming no more massive shocks like the Federal Reserve bond-buying scare, predict interest rates will make another record again sooner or later.

Pre-Bubble Rates

While no one (excluding, of course, the lenders) want to see interest rates rise, current rates are still well below the pre-bubble standard of six or seven percent. Both economists and lenders are aware that the number of mortgages will drop drastically if interest rates climb much higher than 5%, and the federal government has measurements in place to avoid lending at higher rates for those who will be, ultimately, unable to afford it.

Buy Now Or Buy Later?

For potential homeowners with the means or nearly the means, to buy a home sooner is definitely better. While interest rates should remain approximately static for the next year or so, rates will begin to rise. Furthermore, there is an incentive for lenders to offer homes loans at higher rates to more customers, which means more competition in the market.

Already, many potential homeowners have to compete for many houses before they are able to finally purchase a home. And, once rates increase, there is less incentive to offer more competitive rates regardless of credit rating because the demand will be established.

While the market may continue a slight decrease through the end of the year, there is no guarantee. If you are able to purchase a home, or are closing in on your goal for purchasing a home, now is a good time to start looking or negotiating for a home.

What Is Interest and How Does it Work?

If you have ever entered into any type of finance, be that a loan, credit card, mortgage, store card or anything else, you will have come face to face with the complicated world of interest rates. There are interest rates, APRs, yearly percentages and all sorts of other complicated things. 

So how does it all work and how do you know that you are paying what you should pay?  And how do you make sure you pay as little as possible?

What Is an Interest Rate?

An interest rate is basically a fee that is automatically added to the amount you borrow.  There are a lot of things that influence an interest rate, including how much you borrow, how long you borrow it for, what country you live in and what your credit score is.  

To complicate the matter, interest generally drops with your repayments, meaning you pay a whole lot of interest in the beginning and then start to pay less and less interest over time.

For certain financial products, mainly mortgages, interest rates can be either fixed or variable.  With a fixed rate, you know exactly how much interest you will pay each and every month for the duration of your loan, or for the duration of your fixed period. 

With variable rates, the interest you pay depends on what the main financial institution of your country set as the average interest rate, and how your lender then responds to it.  If you have heard of the now global Libor scandal, you will understand that this matter is hugely controversial and complicated.

How an Interest Rate Is Set

As a rule of thumb, the worse your credit score is, the higher your interest will be and the more you will pay each and every month.  That sounds totally unfair, but what people don’t realize is that interest is the way that lenders make their money. 

They lend you a certain amount and the interest is the money that they make in profit.  Their thinking is that somebody with bad credit is more likely to default – not pay – their loan.  So, they want to at the very least earn all their money back as soon as possible and they do this by charging high levels of interest. 

This also means that those people who do have bad credit end up absolutely feeding the lenders, because if they do keep up the repayments, the money these lenders make is astronomical.  This is why it is so important to regularly compare whether you are paying what you should pay.

Comparing the Market

Comparing the market can be very difficult, particularly because of the global economic depression we have experienced for the past few years.  The better your credit is, the better your chances of getting credit with low interest rates.  One thing many people do is keep their eyes on the market and swap or switch their financial products regularly. 

For instance, if you have a balance of £200 on a store card and you have 12 months to pay that off at 0% interest, but after one year you have only paid £100, you have the option of finding a different provider that is willing to take over that £100 at 0% interest again.

Finding interest free credit cards isn’t too difficult if you have a reasonable credit rating.  By using these, you could save high amounts of money on your monthly interest fees.

How to Compare Mortgage Interest Rates?

Deciding upon a mortgage product can be a difficult job. You need to think about several factors before you could get a package suitable for your circumstances. Apart from taking in the quoted rate, you need to consider the closing costs, annual percentage rate (APR) and mortgage points to get an idea about the true cost of the loan.

Ask for Good Faith Estimate

It is advisable to get mortgage quotes from at least three lenders. Request each lender for a print of the Good Faith Estimate (GFE). Each quote will list the loan amount, the monthly interest rate, the loan term and a fair approximation of the closing costs of the mortgage. The upfront closing costs can add a significant amount to the cost of your mortgage.

Comparing Points

Most lenders charge a sum for discount points at closing. One point is equivalent to 1% of the mortgage amount. Lenders offer you a specific discount on the interest rate if you pay the points.

It is crucial to know the rate of the mortgage without the effect of discount points. You may then work out the rate of the product after factoring in the discount points.

Some lenders charge origination points to regain the costs incurred in the loan origination procedure. Origination points do not benefit the borrower. There is no advantage to opt for a mortgage product with origination points unless the other features of the mortgage offer financial benefits.

Compare APR Values

Request each lender for the Truth in Lending statement. This document details the annual percentage rate (APR). The APR indicates the actual cost of the mortgage expressed as an annual rate.

The rate calculates the amount of interest you would have to pay after including the loan origination fees, pre-payment penalties, origination points, discount points, and private mortgage insurance costs. In most cases, a loan offer with a low APR value would indicate a profitable deal for a borrower.

The APR does not give a definite pointer for adjustable rate loans because the lender defines the rate based on market predictions, which can be quite misleading. However, you may consider the APR for deciding upon a fixed rate product.

Other Fees

There are other fees for title insurance, document preparation, property appraisal costs, and various other mortgage services. You must consider the costs involved in each of these items before deciding on a loan product.

Prime Interest Rate in the United States

The prime rate is a term to denote banking interest rates. In the United States, the prime interest rate isn’t the actual interest rate a customer can expect when getting a loan because banks tend to adjust their rates above or below the going prime rate. At the beginning of 2012, the US prime rate was 3.25%.

Applying For A Mortgage

When obtaining a mortgage, it’s important to recognize the current prime rate to better help you to compare loan products. 15-year fixed mortgage rates tend to be right around or just above the national prime rate. 30-year fixed mortgages, however, tend to come with higher rates due to the sheer length of the loan term. When the prime rate is 3.25%, you can generally expect a 15-year FRM to be at a 3.25% interest rate, but a 30-year FRM will fall around the 4.0% mark.

This may not mean much to potential homebuyers who are simply looking for a long-term loan to save them money on monthly payments, but taking on a 15-year mortgage will save you tons of money in interest over the length of the loan, even though you end up paying more per month.

The Power of Federal Reserve

So, who is in charge of setting the prime rate? That would be the Federal Reserve (otherwise known as the Fed). The Fed has the ability to increase or decrease interest rates as it sees fit, although the Federal Reserve Act specifically states that the entity should consider maximum employment, moderate long-term interest rates and stable prices.

This is a tricky business because decreasing the prime rate can stimulate economic growth. The lower the interest rates, the more likely people are to jump on the home buying bandwagon. Increasing interest rates helps control inflation, thereby promoting a more sustainable economy. The idea is to find that prime interest rate that will suit economic growth while keeping prices stable. It’s a thin line to walk.

2011 saw strong inflationary pressures building, but they have receded with the start of 2012. As of now, there is a low inflation outlook and the United States is projected to have moderate economic growth in the New Year.

In keeping with monetary policy, which is the process of controlling the country’s supply of money, economic growth and stability are key. The goals involved in the monetary policy include stabilizing prices to make products easy to purchase and improving unemployment percentages. The lower the unemployment rate, the more stuff people buy, which is always good for the economy.

When it comes down to it, monetary policy rests on how the economy’s interest rates and the total supply of money relate to one another. The Fed controls the availability and supply of money and setting the prime interest rate is more mathematically involved than one might think.

Economic Outlook

There’s not much to be said for the current economic outlook except that things seem to be stabilizing. Unemployment claims dropped by 50,000 by the middle of January, but much of that was probably due to seasonal, temporary employment. Even so, it’s the best news the country has received regarding the unemployment rate since April 2008. With a modest amount of hiring going on and the labor market slowly beginning to recover, there will be a lot to watch for in the early months of 2012.

These are all things to take into consideration if you are in the market to buy a home. Interest rates are at an all-time low and the prime rate is forecasted to stay at 3.25%, at least until August of 2012, so now may be the perfect time to start house hunting.

Before shopping around for that dream home, use a mortgage calculator to determine how much your monthly payment will be, based on the current interest rates. It’s always best to know exactly where you stand financially before seeking out a realtor.

The Highest Interest Rates Come From Online Banks

People are familiar with a savings account; it is ordinarily the first type of bank account that most people open when they are kids. As adults, they have the choice of keeping the money in a high-interest savings account, but they also can choose to branch out into a high-yield money market account, and they can open both types in online banks.

Ally Bank
Ally Bank has a savings account that can be opened with an interest rate of 0.99 percent. The account doesn’t charge any maintenance fees, so depositors don’t have to have a minimum balance.

They can open this account with any amount of money, and the interest will be compounded on a daily basis; this gives the principle a chance to grow faster. People will need to be comfortable with the fact that they can only withdraw money from this account six times in a month.

Ally Bank also has a money market account with a 0.99 percent interest rate. With this account, depositors won’t be paying any fees to maintain it.

They don’t even need any money at all before they open the account, although it probably would be more advantageous to everybody if they deposited at least one dollar. The interest earned will be compounded daily and they will have the ability to write checks on this account.

American Express
The American Express savings account gives people a variable interest rate without a minimum balance or monthly fees. People who open this account receive the benefit of being online because they will have access to their money even at 3:00 in the morning.

The account also allows them to do electronic transfers between accounts. People will be able to enjoy all of these features without fees or minimum balances.

Capital One Bank
Capital One Banks has a high-yield money market account that offers people an interest rate of 0.65 percent for no monthly fees, no minimum balance, and free checks.

If these account holders need to add funds to their checking account from their money market account, they can do it online for free. They can also write as many checks as they like and use their ATM cards as often as needed without charge.

ING Direct
ING Direct gives people 1.00 percent in interest as well as access to their accounts through their SmartPhones or their computers. This account makes it easy and convenient for people to make regular deposits to this savings account without having to do it themselves.

They can decide how much money they would like to contribute, and it will be automatically debited from their checking accounts and credited to their savings accounts.

Every day, the interest in high-yield money market and high-interest savings accounts can change, but lately, online banks have been offering the highest interest rates.

It’s more likely that people will be able to find higher interest rates from an online bank because they are more easily maintained than the traditional banks that have many more expenses and bills. That’s why online banks will continue to be the place to find the best high-yield money market and high-interest savings accounts.

Why Interest Rates Will Likely Begin to Rise?

How Are Interest Rates Determined?

Interest rates are the result of the yield on Mortgage-Backed Securities (MBS). When MBS are sold to investors they are purchased at varying levels of demand. If they are in low demand, the price of the security will go down and the yield (or return) will go up.

This will result in higher rates to the consumer. When there is a high demand for these securities, the price rises and the yield falls – interest rates, in turn, come down. This is simple supply and demand economics.

interest rates
interest rates

Why does the Yield travel opposite the Price?

This is more easily understood using an example. If I could buy a home from you and guarantee my profit when I sell it, that would be like buying a bond. Let’s say I guarantee my profit upfront to be $10,000. If I had to purchase a home at $100,000 to make a $10,000 profit then my return (or yield percentage) would be 10%.

But if I could buy a home for $50,000 and gain the same $10,000 profit, then my yield would be 20%. A bond or mortgage-backed security is simply an investment with a known profit and a variable price. So when the price goes down the fixed yield – as a percentage – goes up.

Who buys MBS?

Until last December (2008) there were two main buyers of these types of guaranteed yield investments. Wall Street is the main investor – mutual fund companies use these securities to offset the risk of owning stocks. The second investors are foreign countries, mostly China and a few others. (China and other Asian countries currently own over 1/3 rd of our debt.) Last December, on their own, interest rates were around 6% to the consumer on a 30 year fixed rate loan with no points based on the activity of these two main buyers.

Enter the US Federal Reserve.

In an attempt to bring long term interest rates to a target of 4.5% and moving as fast at the Treasury’s printing presses could carry them, the US government became a competing buyer for this kind of debt creating a “false demand” for MBS which drove the prices up. This, in turn, caused the yields to decline and at their lowest, the consumer was able to lock in at 4.875% with no points a time or two during the past year.

When will they Stop?

The Fed decided originally to spend around $750 billion buying treasuries, bonds and securities and then earlier this year bumped that to $1.25 Trillion. As of last Friday, $977 billion have been spent leaving $277 billion in purchases over the 22 weeks that remain in the program. The average purchases have been around $20-25 billion per week all year. This will decline to about $12 billion per week through the end of the year and then drop off.

Prices will almost assuredly fall.

If that happens, the rates WILL rise.

Warren Paine

Warren is the senior mortgage loan officer who has worked in mortgages and loan industry since 1995. He study in Harvard and major in Finance with a Bsc. Honor Degree. He possesses a Paralegal Certificate as well.

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