In a perfect world, mortgage interest rates would always be the same. In reality, however, they fluctuate. Depending on your situation, higher rates can make it difficult to buy the home you want or keep up with the payments on your current property. Below, we’ll take a closer look at why mortgage rates change and what you can do to handle them.
Understanding mortgage rates
Mortgage rates, expressed as a percentage of your total loan balance, explain how much interest you’ll owe when you take out a mortgage. While individual lenders decide what specific rates they offer applicants, several large-scale factors impact the rates lenders offer, such as economic conditions, inflation, and unemployment.
Consumer spending, stocks, and bonds may also influence mortgage rates. In addition, the Federal Reserve influences mortgage rates by adjusting the federal funds rate in reaction to inflation and employment. The federal funds rate is the rate at which banks and other institutions lend money to each other overnight.
There are also personal finance factors, like income and credit scores, that will affect the rate lenders offer you. Additionally, some closing negotiations, such as points on a mortgage, can change the interest rate.
If you’re curious about how some of these variables affect the mortgage terms you receive, the Consumer Financial Protection Bureau (CFPB) created a rate tool you can use to quickly monitor interest rates and understand what type of rate you might receive based on your credit, state, house price, and down payment.
Types of mortgage rates
There are two types of mortgage rates:
- Fixed-rate: Fixed-rate mortgage rates remain the same for the life of a mortgage, which may be 15, 20, or 30 years. A fixed rate makes it easy to budget for monthly payments and offers reassurance that payments won’t change due to market conditions and other factors.
- Adjustable-rate: Adjustable-rate mortgage rates stay the same for the initial period, which may be between 3 and 10 years. Then, they’ll change biannually or annually until the mortgage term ends.
Monitoring mortgage rate changes
It’s your responsibility as a homeowner to keep tabs on mortgage rate trends and changes. Fortunately, plenty of news sources discuss the state of the economy, which can give you an idea of the mortgage rate environment. If the economy is doing well, there’s a good chance interest rates will be high. On the flip side, when the economy struggles, interest rates may go down. Keep in mind, though, that interest rate changes are dynamic and complex, so it’s always a good idea to track these changes no matter how the economy is doing.
Rate Locks
The purpose of a mortgage rate lock is to ensure that your mortgage rate will stay the same from the time you receive an offer until you close on your home. A rate lock, usually valid for 30, 45, or 60 days (about 2 months), can protect you from market fluctuations while the lender processes your mortgage.
Without a rate lock, your interest rate and monthly payment may increase as you go through the mortgage process, potentially costing you thousands of extra dollars over the life of your loan. While some lenders offer rate locks once you’re preapproved and have the address of the home you plan to buy, others might wait until the seller accepts your offer on a property.
How to handle rate increases
If you do encounter a mortgage rate increase – whether because you have an adjustable-rate mortgage or as you’re home shopping – here are a few things you can do:
- Modify your budget: With a rate increase, you may need to adjust your budget. A new budget can make it easier to afford a higher rate and monthly payments.
- Plan out your savings: As interest rates change, you may want to plan out further savings goals to accommodate these shifts. This may mean taking a look at how you’re saving relative to your current budget or looking at potential ways to boost your income.
- Tap into your emergency fund: If you’re dealing with a temporary setback and struggling to cover your mortgage payments due to a rate increase, an emergency fund can come in handy. Ideally, you’d have at least three to six months’ worth of expenses saved to give you some cushion without having to completely revamp your entire budget.
- Look into mortgage modification programs: Fortunately, some lenders and government agencies offer mortgage modification programs for homeowners who are facing financial hardship as a result of rate increases. Depending on the program, you may qualify for a lower rate, extended repayment period, or principal reduction.
- Buy down the rate: You may be able to “buy down” your mortgage rate with points. Points on a mortgage usually cost 1% of the loan amount and lower your interest rate by an amount decided by the lender for the life of your mortgage.
How to take advantage of rate decreases
If interest rates go down, refinancing might make sense, especially if you have good credit or a better credit score than when you took out your mortgage. A mortgage refinance can allow you to replace your existing loan with a new one at a lower rate, leading to lower monthly payments or a shorter loan term. If you have the funds, you may also decide to make extra payments on your principal so you can repay your loan faster and save on interest.
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