We all know interest rates go up and down. But do we know why or how that affects each of us on a personal level?
In the last 12 months we have seen interest rates as low as 3.375% on a 30-year fixed mortgage and as high as 5.00% on the same loan. Currently (9/30/13) the interest rates are sitting around 4.50%. What has caused the large shifts in rate?
Mortgage interest rates typically inversely follow bonds, specifically the 10 year T-bill. As the cost of the 10 year T-bill goes up and the yield on return goes down, so do interest rates. As the price of the 10 year T-bill goes down and yields go up, interest rates typically go up. Over the last few years you may have heard the term QE (quantitative easing). This is an economic stimulant program from the Federal Reserve (The Fed) with which they have been putting "cash" into the market by buying assets such as mortgage back securities (MBS). By purchasing mortgage back securities The Fed has been able to artificially drive down the mortgage interest rates. The private investor purchasing MBS is looking for a higher return, while the Fed is more concerned with driving the economy as a whole, not padding their pocket.
As the economy struggled, the Fed continued to purchase assets, thus we had QE 2 and QE 3. The Fed has been buying billions of dollars of MBS per month, continuing to drive the interest rates down. As the economy has slowly improved, the Fed has threatened to slow or stop completely their asset purchasing program. In August, there was discussion that the Fed would begin pulling back as early as the 4th quarter. Interest rates jumped up to most recent highs of 5.00%. In September they reevaluated the economy, jobs and the GNP to realize they may have overestimated the economic growth. At which point, the Fed announced that they did not plan to stop or slow their asset purchasing program and rates began to drop again to our current rate of 4.50%.
How does this affect you, the home buyer?
Here is a quick example: On a $200,000 loan at 4.50% you will pay $1,013.37 / month for principal and interest. At an interest rate of 5.00% you will pay $1,135.58 / month for that same $200,000. That is an increase of almost 11%. To look at this differently, at a 5.50% interest rate, if you borrowed 10% less or $180,000 you would have a monthly principal and interest payment of $1,022.02. With a 1 percent increase in rate you have reduced you borrowing power by approximately 10%. As the price of houses go up and interest rates go up you have reduced your buying power by over 10%. My suggestion, get out there and buy now while your purchasing power is still really strong.
Article written for NELR by Jeff Teplitz, Mortgage Loan Officer, EverBank - Dedicated to helping clients throughout the mortgage process, with over 8 years of mortgage experience and a thorough knowledge of the Vermont and Northern New England markets.
Featured image: homesolid.com