Understanding Interest Rates on Your Home Mortgage
The interest rates when buying a new home, especially for buying the first home, can feel like a landmine that buyers don't even want to walk into. Between the jargon and numbers, it's difficult to get a clear idea of how it all works—especially when buyers rely on their lender to explain it to them. Lenders are trained to sell their products and homebuyers may not understand just how their interest rates will affect them over the next three decades. Learn more about how interest rates impact everything from payments to taxes.
Risks and Threats
It's easy for buyers to look at interest rates as a pure profit strategy for the lender, but those interest rates reflect the risks a lender takes on their customers. If a home buyer can't meet their monthly payments, the lender has to absorb the costs associated with late payments and the potential default of the home. Interest rates are tailored to each customer because there are some buyers who are statistically more likely to default than others.
And now that real estate has been increasing in price in many areas of the US, more and more people are unable to meet the standard 20% down payment recommended across the board for home buyers. Even with Private Mortgage Insurance, an insurance policy taken out by lenders to cover their costs, the financial world has seen interest rates be affected by this trend.
Fixed Interest Rates Vs. ARMs
Most buyers know these mortgage terms, but they may not understand the implications:
- Fixed rates: This mortgage has to take into account how interest rates may change in the future. As such, the initial rates may take some buyers aback. But a fixed-rate also guarantees a buyer's payments over the course of the mortgage. Those who want to settle down in their home for the long-term will appreciate the stability of fixed-rates.
- ARM: Initial rates for an ARM are typically especially attractive to buyers. However, an adjustable-rate mortgage can change the interest rates for a homeowner based on the standard federal rates. And while it's true that rates can go down, they're generally more likely to go up. An ARM may be a good compromise for a buyer who's using the property as a starter home.
- Interest-only: An interest-only loan is an option for homeowners who want lower monthly payments. People with irregular income may take advantage of this option because they don't want to risk coming up short. However, this can be a dangerous choice because, as the name of the loan implies, home buyers aren't addressing the principal of the loan. This can lead the buyer to pay more over the course of the loan.
What to Know About Amortization
The amortization formula is an equation that Liberty Lake home buyers can use to calculate the total they'll pay across the entire life of the loan. It's much easier to calculate on a fixed-rate loan of course, but there are ways to estimate interest fluctuations on an adjustable-rate loan. Buyers should understand that this formula is applied across the entire length of the loan with the interest rate being applied to the estimated principal for each month of the loan.
So if a loan is granted at 3% on a $250,000 principal, then buyers will pay interest on $250,000 at the very beginning of the loan. By the end of the loan when the principal has been pared down, the buyers may only be paying 3% applied to a few thousand dollars. That's why it makes financial sense for people to pay off as much as possible as soon as possible.
How to Control Interest
Homeowners who can pay down their mortgage as much as possible can reduce how much they pay over time. Again, the key is to get the principal down to a manageable level to reduce how much is paid out to interest. One good piece of news for homeowners who itemize their tax returns is they can also typically write off the amount they pay on interest (up to loans of $750,000). A state may also allow partial or total deductions, but a homeowner may need to learn more about their state's rules first. Talking to a real estate advisor or financial planner can make it easier for an owner to set up their returns to make the most of their taxes.
Mortgage rates aren't always easy to calculate because the calculations are based on future events. Even a fixed-rate mortgage may be less expensive than a homeowner thinks if they can pay it off faster than they think. However, knowing the principles can make it easier to make smarter decisions.