For many people, mortgage rates are the most important rates they will consider in their entire lives. Because of this, mortgage rates need to be understood and analyzed. This post delves into correlations that mortgage rates share with other interest rates and the maximum percentage of income that people should dedicate to mortgage payments. Looking at the 30 year mortgage rate graph from FRED doesn’t show much. One can see a huge spike in the rates during the early 1980’s, which can be attributed to high levels of inflation during that time. The closest comparable interest rate is the 10 year treasury rate. The rates almost perfectly match. If one compares the 30 year mortgage rate to a 1 year treasury rate, there is a much greater variance, but the general trends still remain. An important question becomes why the mortgage rate so closely follows the 10 year treasury rates. The answer comes from the average time the mortgage owner actually owns the mortgage. In other words, on average the mortgage is paid off in 10 years. For this reason, the 10 year treasury rate serves as a very accurate measure of the mortgage rate.
One of the more important facts homeowners need to know about mortgage rates is that a lower mortgage rate is better than a higher interest rate. This comes from the monthly payment the homeowner would pay. A lower interest rate means there is less interest to pay to the lender, so the monthly payments are lower. Similarly, a higher interest rate means the homeowner has to pay more interest compared to lower interest rates per month. Another important decision to make on a mortgage is whether to have a fixed-rate mortgage or an adjustable mortgage rate. A fixed-rate means the interest rate remains the same throughout the term of the mortgage, while an adjustable interest rate means the interest rate changes occasionally over the term of the mortgage. What are the advantages and disadvantages of both? When should a homeowner decide to use one over the other? Fixed-rate mortgages are most effective when the mortgage rate is low, while adjustable rates may be a better decision at high mortgage rates. After all, there shouldn’t be many people happy with paying 15% interest on a mortgage for 30 years. An adjustable rate would allow that to potentially fall over the 30 years and save the homeowner a boatload of money.
People can find mortgage calculators all over the internet that allow them to quickly determine how much they would pay every month for a given house price and mortgage rate. This allows a homeowner to determine the maximum mortgage a lender would give. The general cut-off for mortgages is a monthly payment no greater than 28& of monthly income. Most lenders would feel uncomfortable lending money to potentially higher risk homeowners, especially after the Great Recession. Overall, mortgage rates play a huge role in economy and should be understood thoroughly.
Mortgage rates, while very important, do not cross my mind too often, so I appreciate your analysis in this post. I didn’t realize there was an alternate to fixed mortgage rates that was adjustable, and I definitely agree with your point that it depends on the situation as to which one is better. Though I wonder if people can switch from being in a mixed mortgage rate to an adjustable one? Another question that comes to my mind is how easy is it to forecast what the interest rates will be in order to determine whether to do fixed or adjustable? Are these forecasts also accurate looking at past data?
I remember my math professor in high school talking about the differences in mortgage rates in terms of years, and saying how a 30-year mortgage rate was not worth it in terms of paying more in interest rates, and I wonder if he was discussing fixed or adjustable rates.
Overall, very interesting post! Thanks for your insights!
I’m curious how the process of refinancing a mortgage works. I plan on looking this up, but is it possible to refinance coinciding with bottoming rates? How long does the process take? Is there delay which negates the feasibility of this strategy? Additionally, why are most mortgages paid off in 10 years? Do most people pay more than the minimum monthly payment on a 30-year mortgage? Surely not every family would be capable of doing that? Wouldn’t the number of years paying off a mortgage heavily depend on the economic circumstances of the family, as well as the nation, as periods of high rates might make extra payments very difficult?
There’s so much literature out there about millennials not being able to afford homes. Our generation has a very high probability of being renters for life. However, looking at these graphs it seems like there’s never been a better time to buy a home. I wonder how other factors such as student debt are preventing motivated homeowners from purchasing because it would move them to a higher risk. Since these numbers are also the nationwide average, seeing a regional breakdown would help understand key differences in housing markets. If I’ve learned anything from hours of HGTV, it’s that no housing market is created equal and a $1 million budget won’t get you as far as you think in a lot of places.
1: You can generally pay off a mortgage early, that is, refinance. However most new loans carry upfront fees – “points” – that can run 1%-2%. On a median used house price of $250,000 that’s at least $2500. That’s independent of all sorts of other fees (lawyers, insurance, taxes).
2: Variable rate mortgages entail risk, and you may not want to bear that, particularly if you’re not seeing your income grow at a decent rate. In contrast, with a fixed-rate mortgage the real burden falls with wage increases even if they are due to inflation (real wages historically did not fall).
3: There was lots of abuse in the years running up to the Great Recession. Many people were talked into variable rate loans that “reset” (the jargon was deliberate) after (say) 3 years to a higher rate, without being told exactly what that meant for monthly payments. If interest rates rise, it’s not at all unlikely that monthly payments can double.
4: Shorter maturities behave differently from longer ones. But monthly payments fall, so most people need 20-30 year mortgages. Yes, interest payments are higher. But what matters is the monthly payment relative to renting. Remember, you have to live somewhere!!
5: Finally, how likely are you to move? There can be as much as 10% in fees on the sell-side. So if you’re not going to be somewhere very long, buying a house is a bet on house prices rising at a fast clip. Of course this is bundled with other decisions – you may start out single and owning a small condo, but once married with kids you’ll want more space and need to take your partner’s commute into account. [After all you’re likely to marry another professional, what social scientists call “assortative marriage”.]
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