When evaluating a property for purchase, it can be quite tempting to base your decision only on the price if it fits your budget. However, current mortgage rates play an equally important role in determining affordability. The interest rate you pay every month on your loan keeps fluctuating. Even a small variation in the rate, like 1% or 0.5%, can make a huge difference in what you pay for the loans.
For any individual looking for a new home or wanting to refinance a home loan, this blog will help them understand how much the change in interest rate will affect the mortgage payment!
How Do Mortgage Rates Work?
The mortgage rate is a percentage of the amount you pay on your home loan. You'll need to make the monthly payment to repay your mortgage. Initially, interest may take up the majority of the payment. However, with timely payments, the principal amount will be reduced.
Following are the four key components of a mortgage payment, popularly known as PITI -
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Principle: Amount you borrowed as a loan.
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Interest: The total Interest rate on your loan is decided by the money you borrow.
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Taxes: The amount of property taxes based on your property's worth is evaluated by the local government.
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Insurance: Protection of your property from any future mishaps like fire, theft, etc.
There are two rate options for a mortgage, as mentioned below -
Fixed Rate Mortgage
In a fixed-rate mortgage, the interest rate will be consistent throughout your loan period. This will facilitate stability and ease of payment for your monthly payments and budget. Hence, it is best for first-time buyers. With FRM, you will initially have higher interest rates.
Variable Rate Mortgage
In a variable-rate mortgage, the interest rate can fluctuate, which also leads to a change in the mortgage payment. Here, the lender sets a variable interest, depending on the base rate it is tracking. Though it has a lower rate than a fixed-rate mortgage, it may rise if the interest rate increases.
How Much Does Interest Rate Affect Mortgage Payments?
To understand this, let's understand how lower or higher interest rates affect the mortgage payment -
Lower Interest Rates
Mortgage interest rates directly impact the house's affordability. The rate influences the total cost of the home loan, and a lower interest rate means lower mortgage payments. It means you can afford a more expensive home without worrying about increasing your budget.
Refinancing your mortgage to a lower interest rate can also reduce the total amount of interest you pay for the mortgage. For example - if you have a mortgage of $300,000 at 5% interest rate for 30 years, then the interest paid for the duration would be $280,000. However, the total amount would drop to $215,000 if the interest rate was lowered to 4%. But, it is important to consider the pros and cons of refinancing, as it also includes closing expenses.
Higher Interest Rates
Increased interest rates lead to more costly mortgages. For example, if you have a mortgage loan of $300,000 at an interest rate of 3%, the mortgage you pay is $1,655.47. But, if the interest rises to 5.5% for the same $300,000 loan, then the mortgage you pay is $2,013.58. A small hike in the interest rate can significantly affect the mortgage payment.
Fixed-rate mortgages have the same interest rate throughout the duration, which means the interest rate is unaffected by the change. However, if you're opting for a variable-rate mortgage, lower interests offer more benefits.
Factors Affecting Mortgage Interest Rate
Several factors influence mortgage rates. Understanding each of them helps you make sound financing decisions. Here are some of them -
Market Condition/ Economic Factors
The following economic factors influence mortgage rate fluctuation -
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Federal Reserve Policies.
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Demand for mortgages in the market
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Inflation leads to changes in interest rates.
Loan Type and Period
The interest rate may vary depending on the type of mortgage. If you choose a long-term loan, you may have to pay a lower interest rate monthly, but the overall cost will be higher.
Credit Score
If your credit score is high, you may get a lower interest rate. Whereas a low credit score may lead to a higher interest rate. This is because a moneylender evaluates your credit score to check if you are eligible for a loan.
Conclusion
It is crucial to understand how interest rates affect mortgage payments. It ensures you make a sound decision regarding purchasing a new home. It is also important to check your credit score to ensure you get a lower interest rate and terms available.
