It might just be time to buy that home of your dreams or refinance your existing mortgage. According to a Freddie Mac survey released May 3, average rates for a number of fixed and adjustable rate mortgages hit record lows last week, creating a significant savings opportunity for refinancers and prospective homebuyers who’ve recovered sufficiently from the negative effects of the Great Recession.
Ok, but how much savings are we talking here?
Well, a 1% lower interest rate can save a consumer literally tens of thousands of dollars over the life of a mortgage. More specifically, you’d save more than $30,000 on a $200,000 mortgage just by getting a 4% interest rate rather than a 5% interest rate. This would obviously hold true whether you are purchasing a new home or refinancing an existing mortgage.
To be sure, a lot of people around the country are now seriously pondering questions along the lines of “should I buy?” or “should I refinance my mortgage?” Unfortunately, the answers to these questions depend on more than just the interest rates you can expect to get. A number of other factors are also in play, including your disposable income, financial goals, and ability to predict the future.
Yes, being a psychic helps because it’s possible that rates could go even lower than the already historic levels, in which case you’d kick yourself for not waiting longer. On the other hand, if they go up, you’d kick yourself for being greedy. The bottom line is you have a decision to make, and choosing incorrectly might result in some self-inflicted bruising.
In order to make this decision, you need to know where rates are and where they’ve been, so here’s a snapshot of the types of mortgages that hit nadirs recently, along with past benchmarks:
- 30-year fixed mortgages: Averaged 3.84% last week, compared to 3.88% the week before and 4.71% at this time last year.
- 15-year fixed mortgages: Averaged 3.07% last week, down from 3.12% the week before and 3.89% a year ago.
- 1-Year Treasury-indexed ARMs: Averaged 2.70% last week, 2.74% two weeks ago, and 3.14% a year ago.
Average rates for 5-year Treasury-indexed ARMs (mortgages that have a fixed rate for an initial period before becoming adjustable) are also quite low right now, though not at record-breaking levels. Rates have remained steady at 2.85% for the past two weeks and are down from 3.47% this time last year.
How Are Interest Rates Determined?
At this point, you might be wondering exactly why rates are so low and what this tells us about the economy. Well, myriad factors impact interest rates, but one of the biggest is Federal Reserve Policy, and the Fed, interestingly enough, is trying to keep interest rates low in order to jumpstart the economy and counteract slowing growth.
“Low interest rates help households and businesses finance new spending and help keep the prices of many other assets, such as stocks and houses, steady,” according to the Federal Reserve’s website. “In this environment, the Federal Reserve has determined that an accommodative stance of policy with low interest rates is necessary to help promote a stronger pace of economic recovery and to help ensure that underlying inflation does not move even lower over the medium term.”
In other words, the Federal Reserve’s Open Markets Committee – one of the main groups shaping monetary policy in the United States – set a low target for interest rates in order to encourage economic activity (i.e. borrowing, buying, and selling) and thereby put the economy back on track for expansion. This would in turn help bring down unemployment.
In case you’re wondering, some of the other important factors that affect interest rates are as follows:
- Rate of Economic Growth: When the economy is stagnate or contracting, unemployment is high and spending is low. There is no risk of inflation in this environment, so interest rates are kept low in order to discourage people and businesses from keeping their money in banks and instead encourage investing and spending. When the economy is strong, there is already a lot of economic activity, so interest rates are kept high in order to prevent inflation.
- Open Market Transactions: When the U.S. government buys previously issued securities, it infuses banks with money, giving them more than they can lend and pushing down interest rates. When the government sells these securities, they drain money from the banks, and push rates up.
- International Lenders: When international lenders are willing to lend money to the US, it supplements our money supply and drives interest rates down, and vice versa.
This is, of course, a very basic look at how and why interest rates are what they are. Thankfully, you don’t really have to be an expert about this to understand that rates are currently low and it might be the right time to buy or refinance!