If you’re in the market to buy a home, it’s important to pay attention to interest rates. With rates currently just over 4% on a 30-year fixed rate mortgage, you may want to get the ball rolling to lock in a low rate for the long term.
The Federal Reserve, which sets U.S. monetary policy, has been unwinding its multi-year bond-buying program. That program was launched in the wake of the 2008 financial crisis as a way to stimulate the economy and keep interest rates low.
As the Fed pulls back on the program amid the resurgent economy, experts anticipate that interest rates will continue to rise from their lows of 3.35% in 2012.
“Mortgage rates near 4% are extremely low by any reasonable historical standard,” said Don Maxon, a certified financial planner in San Rafael, California.
“The consensus of most economists is that rates will be rising. When rates start rising, they tend to move rapidly. When and if rates come down, they tend to come down slowly. It is easy to become complacent with our low rate environment.”
Higher interest rates means higher payments on fixed-rate mortgages. In fact, just a .25% rate increase can result in thousands of dollars of additional costs. Even worse, a big enough uptick in rates could make buying a home out of your reach. This is why it is so important to understand interest rates and where they are headed.
What determines mortgage interest rates?
There are a number of different factors determining rates, from economic conditions and fiscal policy, to inflation and the supply and demand of credit.
One of the best ways to figure out the direction of mortgage rates is to track the yield on the 10-year U.S. Treasury bond. Treasuries are considered one of the safest financial investments because there is very little risk of default, since they are backed by the full faith and credit of the federal government.
What do Treasuries have to do with mortgage rates? In the U.S., mortgages are packaged into pools and sold to investors as “mortgage-backed securities.” The mortgage-backed security market is closely tied to the bond and Treasury markets. When the yield on Treasuries rises, the interest rate on mortgages should also rise, since investors in mortgage-backed securities are looking for a competitive return on their money.
Mixed or poor economic data means the economy is slowing down, which usually leads to lower rates as investors seek a safe-haven in Treasuries. On the other hand, good economic data means the economy is expanding, which usually leads to higher rates on Treasuries as investors opt for riskier investments.
Right now, there appears to be high demand for Treasuries, with the current interest rate on a 10-year note just 2.61%, down from 3% at the beginning of the year. Similarly, a 30-year fixed-rate mortgage fell to 4.14% last week, down from 4.43% in January, according to Freddie Mac.
“There is huge liquidity in the financial systems that need to be invested, and much of that liquidity needs to be invested in the safer, fixed-income investments of bonds, Treasuries and mortgage securities,” said Maxon. “This demand results in higher prices, pushing interest rates down.”
How you can get a lower mortgage rate?
It’s impossible to predict with certainty how interest rates will move over the next year or two.
If the economy starts to really pick up steam, or inflation takes off unexpectedly, we could see a big spike in interest rates in a short period of time – so waiting for a better rate might not be worth the risk.
No matter where interest rates are headed, there are still a number of steps you can take to get a lower rate. Here are just a few:
Improve your credit score: It doesn’t matter how high or low interest rates are in the market – if your credit score stinks, you probably won’t get a great rate on your mortgage. According to MyFico.com, someone with a credit score of 760 to 850 receives an average APR of just 3.749% on a 30-year fixed mortgage, while someone with a credit score of 620-639 get a rate of 5.338%.
Improving your credit score begins with checking your credit report for errors. You can get a free copy of your report once a year from AnnualCreditReport.com. If you see anything that looks incorrect, such as late payments or amounts owed on loans, you should dispute them immediately with the credit bureau.
Shop around and compare rates: Just like with buying a car, shopping around and negotiating for the best deal is always a great idea. Loan prices can vary from each lender, so you should try to get quotes from multiple lenders to compare. You can then make lenders compete with each other, using the offers as a bargaining chip to get a lower rate.
Get a 15-year fixed: If you are able to afford the higher monthly payments, a 15-year fixed rate mortgage will save you more money on interest. According to Freddie Mac, the average rate on a 15-year fixed is currently just 3.39%, compared to 4.14% on a 30-year fixed.
Buy points: This is also referred to as “buying down the rate.” A point is equal to 1% of your mortgage amount, or $1,000 for every $100,000, and each point you buy should reduce your mortgage rate by .125%. This makes the most sense if you plan on staying in your home for the long-term, because the longer you stay in the home, the more savings you realize. The points you pay to lower the rate may also be tax deductible.
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