How do Interest Rates Affect the Price of a Home?
Interest rates are a fundamental consideration when buying a home - particularly when a buyer is financing through a traditional mortgage lender (as opposed to the seller carrying the note).
In short, interest rates will, ultimately, affect the price of the home as they are an added cost for obtaining a mortgage. Therefore, understanding several aspects of economics – as tied to interest rates – can save a buyer thousands of dollars (if not more).
To better understand how interest rates may apply to your specific situation, speak with your lender and/or financial advisor.
Interest Rate Basics
Quite simply, interest rates are a specific amount a lender charges to borrow an asset. In the case of home buying, that asset is borrowing money to purchase a piece of property over a fixed period. Essentially, consumers are paying for the privilege to use an asset they do not own. Meanwhile, lenders are generating income from an asset they do not have access to as it is being used by the borrower.
Interest rates come in two varieties: short term and long term rates. A mortgage or a car loan are prime examples of long-term interest rates since the length of the loan spans many years. Credit cards are an example of a short-term interest rate as they are constructed to be paid off very quickly – within a year or less.
There are three main factors that influence interest rates on a national level.
- The Federal Reserve (also known as "the Fed") has the power to raise or lower interest rates. They do so by using what are called predictive models which are based on extensive mathematical calculations. Arguably, the "Fed" has a powerful and direct effect on short term interest rates.
- Investor demand for Treasuries—meaning bonds, notes, and bills— have a powerful influence on long term interest rates. Essentially, Treasuries are an investment product used by the U.S. government to raise capital. In return, the investors receive interest payments at fixed intervals. At the very least, investors are guaranteed that their initial investment will be returned. This makes Treasuries an extremely safe investment product.
- The banking industry does have a say in their interest rate structure. Banks loan money to each other. This, in turn, means that banks treat each other as consumers. Consequently, banks pay interest rates to each other. This does factor into the interest rates they charge individual consumers.
Interest Rates And Home Buying
Higher interest rates tend to lower demand for borrowing money. This is a natural consequence of charging consumers more for initiating debt. If it's more expensive to buy something, then people think twice about spending the money (especially businesses making large purchases).
However, in addition to the "Big Three" above, mortgage interest rates, specifically, are dependent upon additional factors:
- Buyer Credit Score
- Home Location
- Down Payment
- Loan Terms
- Type of Loan
Though basic long and short term interest rates are established at the national level, banks do have the ability to charge a different rate to the consumer. Certainly, there are regulations at the state and federal levels as to how this can be done. Yet, a buyer with a lower credit score who intends on purchasing property in a high crime area is a riskier venture for the lending institution.
As such, banks can offer a mortgage at a higher interest rate. Also, a down payment decreases the principle of the loan. Consequently, this can affect the interest rate as the less money that is owed reduces the bank's liability should the buyer default on the loan.
Improving Your Credit Score to Lower Your Interest Rates
A good credit score means being able to borrow money for a home at a lower percentage rate. In order to purchase a home, having a decent credit score is vital. The lower a credit score is, the better the rate will be to purchase a home. There are a number of ways to improve a credit score before applying for a mortgage.
It will take time to get a credit score up, but it can be done by paying off balances on credit cards and always paying attention to paying bills on time. In general, once you are able to pay off your credit balances, your credit score should start to rise. Missing payments can kill your credit score, so it is important to stay on top of your bills and keep everything under control.
Conclusively, many elements are at play in calculating interest rates for home buying purposes – whether you're buying a house in Round Rock or purchasing a luxurious condo for sale in downtown Austin. By and large, a good credit score and a sizable down payment are a solid starting point for securing a favorable monthly payment.