Mortgage Calculators and Interest Rate Movements

Mortgage rates are always of great concern to borrowers seeking a new home loan.  The monthly mortgage payment is generally the largest contractual monthly payment consumers make.  This payment also represents a debt attached to the largest asset most consumers will ever own.  The significance of mortgage interest rates can not be under estimated.  Interest rates entered into mortgage payment calculators are used frequently to calculate mortgage affordability, mortgage calculators are used to asses cost savings when refinancing, interest rates are entered into mortgage calculators to experiment about rate changes for adjustable rate mortgages, interest rates are the key component in almost every mortgage calculator.

What drives mortgage rates and what factors should be considered in evaluating mortgage rates should be a fundamental consideration for all borrowers.  The borrowers who do not understand the value of mortgage rates are those that often do not truly understand the significance of the mortgage debt they have or about to incur.  If a borrower is considering using a mortgage calculator to evaluate the differences between a 30 year mortgage and a 15 year mortgage they should not only understand how different terms impact the monthly payment but why there is also a rate difference between the two similar products.  If a borrower is weighing the advantages of an adjustable rate mortgage versus a fixed rate mortgage and is prepared to enter the different interest rates in a mortgage calculator it is important to understand the magnitude of the spread between the adjustable rate index and the fixed interest rate.

Mortgage interest rates are very highly correlated with U.S. Treasury securities.  Since the average mortgage lasts between 3 to 5 years it better to gauge mortgage rates on the 10 year U.S. Treasury bond as opposed to the 30 year bond.  This is a good barometer for 15 year and 30 year mortgage rates.  Home loans with short initial terms, such as those on adjustable rate mortgages that may be fixed for 1 to 3 years and then adjust, will follow shorter-term Treasury securities.  Understanding this relationship is important mostly because it is generally easier to follow treasury rates rather than mortgage rates.  If the 10 year Treasury rates head up, it can be expected that mortgage rates are heading up as well.  If a borrower is considering using an adjustable rate mortgage, when they enter the present rate into a mortgage payment calculator they should be aware that rates are heading higher and be mindful of how the rate on the adjustable rate mortgage may change in the future.

An important but often overlooked concept for adjustable rate mortgages is to compare the rate difference between the adjustable rate mortgage and the 30 year fixed rate mortgage.  As simple as this concept appears it is far more difficult to evaluate.  In low rate environments, the spread or difference between the start rates on an adjustable rate mortgage may be smaller than it has been historically.  In these cases, even thought the adjustable rate mortgage calculator shows a lower payment, the payment difference between the fixed and adjustable rate is probably not worth the added risk of payment shock that can come with an adjustable rate mortgage.  Furthermore, since adjustable rate mortgages often have low start rates, the real rate to watch is the fully indexed rate.  This is the rate the index that the adjustable rate mortgage is based on plus the margin.  On most adjustable rate mortgages this rate is higher than the initial start rate and can often be close to the interest rate on a 30 year fixed rate loan.  When short term rates and long term rates have a small spread, that fully indexed rate is generally closer to the 30 year fixed and the adjustable rate mortgage advantage diminishes.  These are important points when using mortgage payment calculators to compare loan products.

Gauging what causes mortgage rates to change means spotting and defining those causes that affect interest rates in a well timed approach.  As interest rates decline or increase, investments in mortgage products change which in turn changes the rate.  The rate changes will depend upon the direction of economic growth, inflation, the demand for the given product, and other factors.

The number one guide to future interest rate movements is economic data.  Often consumers view the actions of the Federal Reserve as the primary driver of mortgage rates.  This may be partially true.  The Fed does not set mortgage rates or the prime rate.  The Fed simply controls the money supply to influence short term rates, specifically the fed funds rate.  The Fed applies pressure to raise or lower the interest rates to help address increases or decreases in economic activity.

Lower short term rates can have an immediate impact on bringing down the rates of adjustable rate mortgages.  Lower short term rates also helps banks to make a variety of loans more cheaply and that can help to generate greater economic growth.   Higher fed funds rates and subsequently other short term rates tend to dampen demand, helping to keep inflationary pressures from forming.  Fed movements do not control rates they simply influence short term rates as a reaction to economic activity and inflation levels. The economic climate can affect mortgage rates more profoundly than other interest rate sensitive securities.  For these reasons, it may be prudent to keep an eye on key economic statistics including inflation figures.  Mortgage rates can change rather abruptly, often changing during the day.  If the data entered into a mortgage calculator does not accurately reflect the days mortgage rates, that output form that mortgage calculator will have less value.

There are many variables that can influence the interest rates that are used by mortgage calculators to calculate various aspects of home loan analysis.  An understanding of how interest rates move and key economic indicators can provide clues to the future direction of interest rates and help to avoid entering data into the mortgage calculator that may be irrelevant.

This entry was posted on Thursday, December 11th, 2008 at 1:52 pm and is filed under Mortgage Articles. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.