You're considering becoming a homeowner for the first time, this is an exciting time! Before you start scheduling visits to potential properties, do some homework on mortgage interest rates to make sure you make a smart decision and get the most house for your money.
Interest Rate Basics
First, let's start with a definition. An interest rate is the cost of borrowing money. In this case, the interest rate applies to how much it will cost you to borrow money today to purchase a home, rather than waiting until you've saved the entire purchase amount.
There are two types of loans, secured and unsecured. An unsecured loan is a loan for something that doesn't have collateral, like a credit card. A home loan is considered a secure loan since if you default on it, the bank can take your home. Since mortgage loans are collateralized, these interest rates are usually much lower than credit card interest rates since they pose less of a risk to the lender.
What affects your home loan interest rate?
The interest rate you receive reflects the risk the lender takes on in the event you can't pay the loan back. The larger the risk that you'll fail to pay the loan, the higher the interest rate. Your credit score plays a key factor in deciding your interest rate as well. The lower your score, the higher your potential risk is to lenders, resulting in a higher interest rate for you. Higher credit scores mean lower interest rates. For a low credit score (in the low 600s), your interest rate could be as much as 3% higher than someone with a credit score in the mid 700s.
Before factoring in your credit rating, the Federal Government sets the interest rate at which the banks borrow money. The lower the rate set by the government, the lower the cost for banks borrowing from the government, and in turn, your rate is also lower. The government usually lowers rates to stimulate the economy. When the cost of borrowing money is lower, people tend to take out more loans, spending money on big ticket items like homes and vehicles.
Inflation (the rise of prices of goods and services over time) also factors into the cost of borrowing money. As the economy grows, the inflation rate grows. The inverse is also true when the economy is growing slowly or experiencing a downturn. This is when inflation rates are lower.
Should interest rates have an impact on when I buy?
You certainly can't control when the Federal Government adjusts interest rates, but you can seek the advice of economic experts. These experts can speculate if rates are predicted to rise or fall. The timing of changes may affect when you decide to secure a mortgage. If rates have been at a historical low for a few years, and the chances of the rate moving lower is pretty slim, you may want to secure a mortgage now, before rates rise in the future.
The other thing to consider is that even if you secure a mortgage, and then rates fall in the coming years, you may be eligible to refinance your home at a lower rate. This takes away some of the worry when you purchase a home. Knowing that your rate isn't set in stone forever can give you some peace of mind.
What's considered a good interest rate?
When you're shopping for mortgage rates, plan to do your homework and gather as many written offers as possible. The most important thing to consider when pricing a mortgage is calculating your payments. Your mortgage payment should account for no more than 30% of your total household income. If you've found a good interest rate, can afford the mortgage payments, and you plan to own the home for at least 10 years, choose the lowest rate with a reputable lender.
As you demystify interest rates, prepare to do some research and talk to some local reputable mortgage brokers. I help home buyers connect with trustworthy lenders all the time, so if you don't have one in mind, I can recommend a few. Get in touch, and I'd be happy to pass along some suggestions.