Understanding Mortgage Interest Rates
What is an interest rate, exactly, and how does it impact me? Together with loan amount, the interest rate of your loan determines your monthly payment. This is why you can afford a lot more house when interest rates are low than when interest rates are higher.
Mortgage interest rates fluctuate daily. Over the course of several weeks or months, these fluctuations can add up to big changes. For instance, if interest rates went from an average of 5.77 percent to 6.33 percent it could add $100 to the monthly payment on a $150,000 mortgage.
Fixed-rate vs. adjustable-rate mortgages
Mortgages can be structured in a dizzying multitude of ways, but when it comes to the interest rate, there are really only two varieties of mortgages: fixed-rate and adjustable-rate. In a fixed-rate mortgage, the interest rate and your monthly payment remain unchanged for the life of the loan (until you pay off the mortgage, refinance or sell your home, whichever comes first).
By contrast, the interest rate of an adjustable-rate mortgage (ARM) changes – which means your payment can change too. If interest rates rise, your payments could go up. If rates fall, your payments could go down. Because you, the borrower, are assuming more risk (via changing payments), lenders are willing to charge you less interest. Hybrid adjustable-rate mortgages offer an initial period of fixed-rate interest – usually three, five, or seven years. (The longer the fixed-rate period, the less of a discount on the rate you tend to get.) Hybrid ARMs can allow borrowers to benefit from an adjustable-rate interest rate with fixed-rate predictability.
Interest rates and the mortgage application process: Locking in, floating down
While you are in the process of buying a home or refinancing your current mortgage, keep an eye on the interest rates. Even a hike of half a percent on a $150,000 loan can raise your payments by $50 per month. If rates are rising, consider “locking in” your rate before you go to closing – basically, the lender assigns your loan that day’s interest rate for a set period of time (often 30 days). Some lenders will also give you the option of a “float down.” A “float-down” allows you to take advantage if rates drop before you close. Of course, this option comes at a price. Say you lock in your rate at 6% and then two weeks later the rates are down near 5.5%. The lender may let you take the lower rate – for a fee. Make sure to do the math to make sure the monthly payment savings are worth the additional cost.
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