Today we launched the Trulia Mortgage Center, available online and on dedicated iPhone and iPad apps, to help prospective homebuyers and current homeowners get personalized, real-time mortgage quotes. In honor of our newest offering, I wanted to answer the three questions about mortgage rates that I get asked most often.
First: how do mortgage rates affect the housing market?
Let’s start with the obvious: the mortgage rate determines the interest you pay on your mortgage loan when you borrow in order to buy or refinance your home. Your monthly mortgage payment includes (1) the interest you owe on your outstanding loan balance and (2) a portion of the principal itself, which reduces the remaining loan balance. The mortgage rate really matters because a one-percentage point difference in mortgage rates translates into at least a 10% difference in the monthly mortgage payment. For example: on a standard 30-year fixed-rate mortgage, the monthly payment on a $200,000 loan would be $955 for a 4% mortgage versus $1074 for a 5% mortgage. That’s a monthly difference of $119.
You might think that low rates encourage people to buy homes, but it’s not quite that simple. Lower mortgage rates do make homeownership cheaper, but lots of other factors go into the decision about whether to buy a home. Among renters who are interested in buying, saving for a downpayment is a bigger obstacle than being able to get or afford a mortgage. And, because low mortgage rates can signal a weak economy (see next question), homebuying can slow down even when rates are low. At the height of the housing bubble in 2005 and 2006, when homeownership and home sales peaked, the 30-year fixed mortgage rate hovered between 5.5% and 7%; since then, homeownership and sales have fallen, even though mortgage rates have been dropping since 2007 to less than 4% this year.
Mortgage rates have a more direct impact on refinancing. Unlike buying a home, which depends on lots of other economic and lifestage factors, refinancing depends only on whether the gap between your mortgage rate and current market rates is large enough to be worth the paperwork and fees of refinancing. With rates at record lows this year, refinancing activity hit its highest level in three years – and is much higher than refinancing levels in the peak bubble years of 2005 and 2006.
Second: why are mortgage rates so low, and will they stay low?
Today, mortgage rates are below 4%, the lowest level in many decades. Many economic and political factors affect mortgage rates. Three factors explain why they’re so low today:
- The state of the economy. In a slow-growing economy, investors worry little about inflation. Also, households and businesses have below-average demand for borrowing money. These are two reasons why mortgage rates (and other long-term interest rates) are low in a slow economy.
- Government policies. The Federal Reserve has pushed mortgage rates lower through “Operation Twist” and quantitative easing. Why is the Fed doing this? To stimulate the sluggish economy: the government hopes that lower mortgage rates and other long-term interest rates will boost homebuying and other investments, in order to speed the economic recovery.
- Investors’ demand for safe assets. In times of economic uncertainty, investors want to put their money in safer assets. They compare different asset classes – like bonds, stocks and commodities like gold – across different countries. Believe it or not, despite the growing U.S. federal deficit and the housing bust, American mortgage-backed securities and government bonds are considered safe assets – especially relative to assets in countries that are in worse fiscal shape, like the Eurozone crisis countries. Because investors think U.S. mortgage-backed securities are relatively safe, mortgage rates stay low.
Will rates stay low forever? Nope. If and when the recovery accelerates, the demand for borrowing money will rise and inflation concerns will emerge again, which would raise rates. Furthermore, in a stronger economy, the Fed would pull back on policies designed to lower rates, removing a second reason for low rates. On the other hand, a devastating financial crisis in the U.S. could also send rates upward if investors decided that U.S. mortgage-backed securities were no longer safe assets.
Third: How can you get the lowest rate possible?
Now for some news you can use. How can you get a mortgage rate at today’s low rate of 3.60% — the average reported by Freddie Mac in August — or even less?
Your credit score matters a LOT: the higher your credit score, the more willing banks are to lend you money at a low rate. People with a great credit score may be able to get a mortgage rate that’s a full percentage point or more lower than people with a just-OK credit score – and remember that a mortgage rate difference of one percentage point will lower your monthly payment by 10% or more. You might not be able to improve your credit score the night before you apply for a mortgage, but you can at least check it to make sure there are no mistakes on your credit report. And, of course you should avoid doing anything that might worsen your credit score when you’re applying for a mortgage like borrowing all the way up to your credit limit or forgetting to pay your bills.
You might also be able to get a lower mortgage rate if you think hard about the type of mortgage you really need. A traditional 30-year fixed rate mortgage guarantees you a flat monthly payment with no surprises. But other types of mortgages carry lower rates, such as a 5/1 adjustable rate mortgage (ARM), which locks in a low fixed rate for five years and then adjusts annually to the prevailing mortgage rate, which could be much higher than today’s rates. If you’re willing to take that risk – or if you know you’ll need the mortgage for less than five years – you might be better off with a non-traditional mortgage. But, remember, lots of people lost their homes in the housing crisis because they were saddled with risky mortgages that turned out to be a bad bet.
Finally, shop around! You might find or negotiate a lower rate if you compare mortgages from different lenders. Start at the Trulia Mortgage Center for personalized, real-time rate quotes from multiple lenders to find your best financing deal.