How do Interest Rates Affect Mortgages/Housing Market?

The Relationship Between Interest Rates, Home Price, and the Cost Ownership

Every home purchase involving a mortgage includes two major financial considerations: the price of the home and the loan’s interest rate. How do these two elements affect the overall cost of homeownership, and how might they affect your decision to purchase a home? We’ll address this topic by explaining the dynamic between your interest rate, the price of your home and the cost of homeownership.  

To help us demystify this relationship, we invited Jaime Bargiel, SVP of Sales & Marketing, and Michael Cooney, EVP at Shea Mortgage, to provide their insight. 

Fist we'll review some general terminology for interest rates and mortgages.

What are Interest Rates? 

An interest rate is an additional amount charged on top of the principal amount by a lender to a borrower for the use of an asset. Assets can include cash, consumer goods, vehicles, or property. 

What are the Different Types of Mortgage Interest Rates?  

Mortgage loans can be categorized in different ways with the two primary forms being fixed-rate and adjustable-rate. Additional common options include hybrid, FHA, and VA mortgages. Each of these options has a few variations with its own unique interest rates. Find out which loan is best for you.  

Fixed-Rate Mortgages 

Fixed-rate mortgages have a fixed interest rate throughout the life of the loan and are one of the most popular mortgage options. The main advantage of a fixed-rate loan is that the interest rate will not change over time even with market fluctuations. Monthly mortgage payments will remain the same each month.  

Adjustable-Rate Mortgages (ARM) 

An adjustable-rate mortgage (ARM) begins with a low-interest rate that is fixed for a specified initial period of the loan term. After this initial period is up, the interest rate will "adjust" at specified intervals during the remainder of the loan term. The main advantage of an ARM is that they have lower interest rates, which means lower monthly payments at the beginning of the loan term. The lower payment makes it easier for borrowers to qualify for more expensive homes than they otherwise could. 

Hybrid Mortgages 

Hybrid mortgages combine both elements of a fixed-rate and an adjustable-rate mortgage. They start off as a fixed rate for a set number of years and then convert to an adjustable mortgage. The main advantage of this loan is that the fixed-rate portion usually has a lower interest rate than a 30-year fixed mortgage.  

FHA and VA Mortgages 

The two most common types of government-insured loans are Federal Housing Authority (FHA) and Veteran’s Administration (VA). In these loans, you will essentially go through the same process as a conventional mortgage with additional paperwork. Given the government backing, these loans can help people qualify for a loan that may not have been able to. First-time buyers often qualify for an FHA loan and veterans for a VA loan.  

How are Interest Rates Determined? 

Mortgage interest rates are determined by a combination of market and personal factors. Typically, a lender will start by evaluating the current cost of borrowing in the economy. This value is based on overall economic health and monetary policy. A lender will also consider personal circumstances such as your income, credit score, the size of the home you are purchasing, the price of the home, your down payment, and even your debt. 

What Factors Affect My Mortgage Interest Rate? 

Mortgage Points 

Several additional factors can affect the total cost of a mortgage, like a concept called mortgage points, where you buy “points” during the mortgage process in exchange for a reduced interest rate. Each point is 1% of your loan amount. For example, if your loan amount was $100,000, your point would be worth $1,000. 

You can think of this concept as essentially prepaying a portion of the interest on your loan. This works best in favor of homeowners who plan to stay in the home for an extended period to recoup the prepaid interest. These are typically borrowers with a long-term fixed mortgage. However, mortgage points are also available to use on adjustable-rate mortgages.   

When deciding if mortgage points are right for you, the key is to determine how long you plan to stay in the home. If you happen to sell your home before paying off the loan, then it’s possible you may have paid more up-front in points than you made up with your reduced interest.   

Cash Payments 

Additionally, some homeowners use extra cash, like a tax refund or bonus, to make additional payments to their mortgage. Making extra payments on your mortgage can significantly reduce the loan term, which ultimately will lower the amount of interest you will pay overall. While this may set you back in the short term, it does have the potential to save you money in the long term. 

Personal Factors 

The rate determined by your lender reflects personal factors such as your income, credit score, and the type of home you are purchasing. For example, lenders will often use your credit score to predict how reliable you’ll be in repaying your loan. In general, candidates with a higher credit score will receive a lower interest rate than those with lower credit. Similarly, if you put a higher down payment on a home, a lender will see a lower level of risk, therefore granting you a lower interest rate.   

How Do Interest Rates and Home Price Impact the Cost of Home Ownership? 5 Common Misconceptions  

There are a few common misconceptions about mortgage rates that can affect a new homeowner’s perception of how much they’ll owe. Jaime Bargiel, SVP of Sales & Marketing, has provided some insight to debunk these myths.  

1. Your interest rate reflects the total cost of your mortgage.  
   
   While it is true that your interest rate is a part of your mortgage, there are several other components that make up your mortgage rate. These include taxes, like property tax; insurance, like homeowners' insurance; the principal; and yes, the interest rate. 

2. Your pre-qualified mortgage rate quote will be your actual mortgage rate.  
   
   The pre-qualification process is a review period in which the lender will review your financial picture to estimate how much the borrower can expect to receive. This process does not include a credit score analysis, so your pre-qualified mortgage rate will not always match your actual mortgage rate. The pre-approval phase is the next step in the mortgage qualification process, which will give you a much more accurate interest rate. 

3. Mortgage rates are only released once per day. 
   
   Mortgage interest rates are variable and can change on a daily or even hourly basis. This is dependent on economic conditions, in general, it is safe to assume your interest rate is not 100% secured until you receive written confirmation from the lender. 

4. Your best credit score is used in your loan approval. 
   
   If you’re planning on applying for a mortgage, the credit score you will be evaluated on will likely differ from what you expected. While the FICO® 8 model is the most common model for general lending decisions, mortgage lending officers utilize FICO® Score 2 (Experian), FICO® Score 5 (Equifax), and FICO® Score 4 (TransUnion). These scores place less of an emphasis on credit utilization and instead place more weight on payment history. If the borrower’s scores vary, a lending officer will use the median score.  

5. Advertised mortgage rates will always be the rates you receive.   
   
   Advertised mortgage rates may not always match the rate you are qualified to receive. This can be due to a number of economic and personal factors. Advertised mortgage rates are often based on a scenario with the “ideal” loan candidate. This means lenders will promote the best rate, provided the borrower can meet their credit score and down payment requirements. In general, it is safe to assume that advertised rates will almost always be lower than what you may receive, so it is important to be flexible and find a lender that will help you find the best rate.  

How Do Mortgage Interest Rates and Home Prices Impact the Cost of Homeownership

When buying a home, the overall mortgage cost is calculated based on the total amount paid back to the lender over the life of the home loan. The overall cost of the mortgagee can vary depending on the interst rates, loan term, down payment amount and home prices. Some times, mortgage interest rates and house prices have an inverse relationship: If interest rates are low but a home price is high, it is possible the overall cost of the mortgage may be lower than if interest rates were high but home prices were low.

What Happens to House Prices When Interest Rates Rise?

Due to this inverse releationship, when interest rates rise, it is possible that home prices may fall.  When interest rates are low, the demand for property tends to increase, and may drive up housing prices.  Conversely, higher interest rates may decrease the demand for property.  Use our mortgage calculator to run various financial scenarios.

How Does The Federal Reserve System Affect Interest Rates? 

Before deciding to act on a lower mortgage rate, it’s important to understand how these rates are influenced nationally. While the Federal government does not actually set mortgage rates, it can affect them. Michael, Shea Homes financial expert says, “The Fed determines the federal funds rate, which impacts short-term and variable rates. When the federal funds rate increases, it becomes more expensive for banks to borrow from other banks.  Higher costs may be passed on to consumers in the form of higher interest rates on lines of credit, auto loans, and potentially mortgages.”   

Additionally, a lender’s mortgage rates can be affected by other factors, such as federal “monetary policy.” For example, when there is an increase in the money supply, interest rates will fall. Conversely, when there is a decrease to the money supply, interest rates rise. Thus, a lender’s ability to offer a low mortgage rate is influenced by external factors that often fluctuate.   

When is a Good Time to Buy a House? Is It When Interest Rates are Low? 

The best time to buy a house is dependent on your financial capabilities and the many factors that affect each particular mortgage. In some cases, a low-interest rate can help with a mortgage’s overall affordability and positively influences monthly payments manageability. However, if you’re on the fence about buying a more expensive house, consider Jaime’s wisdom: “The best advice for potential new homeowners is always to purchase a home that you feel is within your range of affordability. With lower interest rates, a buyer could potentially qualify for a mortgage on a home that is priced higher than they initially thought they could, which can be great news! That said, just because you can qualify for a larger purchase price doesn’t always mean that’s the best choice for you. A buyer should evaluate their proposed mortgage payment and purchase a home at a price that provides a payment they will be comfortable with each month in addition to their existing liabilities.” Consult with a Shea Mortgage Loan Counselor to learn more.  

Furthermore, it’s wise to consider any additional obstacles in your life that may make buying a house risky. These can range from issues saving for a down payment, fluctuations in your job, or recent credit events that may affect your score.  

Whether you’re looking to buy a house now or in the coming years, stay aware of the changes in interest rates and include them as a factor when you consider the range of what you can afford. While it may not be wise to buy the more expensive house, you might be able to afford more than you expected. You may be able to save money to fix up an older home or perhaps buy a new construction.