Fast Fact: A 1% increase can cut home buying power by over 10%.
Our Economy Impacts Rates… And Vice Versa
One of the ways our government keeps the economy on track is by influencing interest rates. Think of interest as the cost to borrow and use money. Lowering rates encourages people and businesses to borrow and spend, which helps grow jobs and the economy. Conversely, raising rates has the opposite effect, moderating growth and controlling inflation.
Our government continually monitors economic indicators, such as unemployment, inflation, and gross domestic production, in order to gauge whether the economy is growing too little, too much, or just right, and bases rate decisions on these indicators. A premature move could send the economy back into a downward spiral, but waiting too long can cause inflation. Because government prefers erring on the side of the latter, rates have been kept low.
One of the ways our government keeps mortgage rates low is by purchasing mortgage loans from banks which makes the banks more eager to make these loans. But the government has been scaling back mortgage purchases and, on October 29th, announced that it’s ending purchases altogether and may take other steps towards raising rates in 2015.
How Do Lower Mortgage Rates Boost Home Sales?
Low mortgage rates mean lower mortgage payments and more affordable homes,which encourages home buying. Higher rates have the opposite effect and can discourage home buying or require that buyers shop for smaller, less expensive homes.
- A 1% rise in the mortgage interest rate can cut home buying power by over 10%. If a buyer is looking for a $350,000 home, that higher rate can reduce his home buying budget to only $310,000.
Higher rates mean that more of an average homeowner’s monthly mortgage payment will go towards paying the bank interest, rather than saving home equity and building the homeowner’s personal wealth. As a result, home buying decisions, consumer confidence and spending can be impacted.
Higher rates also mean that as many as 3.6 million would-be sellers, who purchased or refinanced their homes when rates were low, will experience “rate lockdown.” That’s what happens when a homeowner is unable or unwilling to sell because doing so means losing his low rate and monthly mortgage payment.
Navigating Rising Mortgage Rates
The good news is that you know what lies ahead and can prepare:
- Clean Up Your Credit. The most pristine buyers get the best rates.
- Do Your Homework on Rate Locks. Some lenders offer free shorter term locks or allow you to break a lock under certain circumstances. Some lender lock rates are actually higher than their current market rates without a lock. In anticipation of rising rates, some are already offering lock options as long as 270 days or will even allow you to lock before you find a home.
- Consider Rate Buy Downs. Eager home sellers are sometimes willing to pay points to buy down your mortgage interest rate, making their home more affordable for you to buy.
- Adjustable Rate Mortgages (ARM). ARMs earned a nasty reputation when the real estate bubble burst, but under the right circumstances, an ARM can increase your buying power and reduce your monthly payment.
- It Pays to Negotiate. Savvy borrowers with decent credit pay one-quarter to one-half of a point less than average borrowers!
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