Demystifying Mortgage Rates

So, you're considering a home purchase or a refinance – fantastic! But have you ever wondered how such seemingly small differences in mortgage rates can translate into real dollars?

Understanding the factors behind mortgage rates and how they affect your borrowing power is crucial to ensuring how far your dollars can take you.

The Rate Rollercoaster

Mortgage rates are influenced by a complex web of forces, including the bond market and the overall health of the economy. When the bond market is strong, mortgage rates tend to dip. This is because lenders use mortgage-backed securities to raise money, which are basically bundles of mortgages sold to investors (Margo Robbie gives an unusual, yet accurate definition in the movie The Big Short).

When demand for these securities is high, competition drives rates downward to attract borrowers. Conversely, when demand drops, interest rates begin to climb.

The Federal Reserve also plays a role in mortgage rates. It is responsible for adjusting short-term interest rates, which indirectly impacts mortgage rates. A lower federal rate generally translates to lower mortgage rates, and vice versa.

The 1% Factor

How much does a change in rates matter? It matters quite a bit, as a seemingly small change in mortgage rates can significantly impact the amount you can borrow.

Let’s break down the math.

Suppose you are looking at a $300,000 mortgage at a 30-year fixed rate. If the interest rate is 4%, your monthly payment (excluding taxes and insurance) would be approximately $1,432. However, if the rate increases to 5%, your monthly payment jumps to about $1,610. This $178 increase per month could affect your ability to qualify for the loan or how much you can comfortably borrow.

On the flip side, let’s say your maximum monthly mortgage budget is $1,432. The same 1% increase would reduce your buying power from $300,000 to $267,000. That’s a lower home value for the same payment.

Why Banks Want You to Refinance

Banks often encourage refinancing, even at lower rates, because they benefit from the interest-heavy initial payments. If you refinance early in your mortgage term, you essentially restart this cycle in which you pay more interest initially. Banks love this, and it is why you may receive so many refinance offers at lower rates than your current mortgage (if the market allows, of course).

Unless you refinance to a term that matches or is shorter than the remaining duration of your current mortgage, banks stand to gain substantially from the interest. When considering a refinance, it is important not only to understand how refinancing impacts your finances today but also your plans for the future.

You may not want to have mortgage payments after retirement. On the other hand, you might prefer more money in your pocket today to enjoy the things you love. Work to understand all the elements of how mortgages operate, and you will become empowered to make informed decisions about your financing options