Interest Rates
Interest is the fee paid on borrowed capital, which for mortgage purposes, is displayed as a percentage of the total amount borrowed and is called an “Interest Rate”.

“Who is the Fed Chairman?” and “what does he have to do with my home?” you may ask. The answer is both plenty and not a lot. To explain, here’s a greatly oversimplified description of how the Federal Reserve Chairman influences your interest rates: The Federal Reserve Board, of which the Federal Reserve Chairman is the speaker, meets 8 times a year (or more as warranted) to discuss inflation, U.S. market conditions, and other economic data. Depending on the outcome of this discussion, they will typically raise, lower, or hold even two key interest rates: the Discount Interest Rate which is the rate of interest the Federal Reserve charges to banks to whom the Federal Reserve itself loans money, and the Federal Funds Rate which is the rate of interest that the Federal Reserve “suggests” should be charged when one bank loans money to another*. Neither of these two interest rates have a direct link with mortgage rates, however they do have an impact on the Mortgage Bond Market, which does impact mortgage rates (along with market demand, market stability, market solvency – the overall ability of people to pay their debt as viewed from a market perspective, and overall financial market conditions). The Prime Interest Rate, what banks charge their best mortgage customers (not typically what the majority of us qualify for), is based upon Mortgage Bond Market Yields adjusted for the conditions stated above, plus a margin added by the lending institution. The interest rate offered by banks to their average customers will be this Prime Interest Rate plus a percentage calculated by the bank based on how much risk they believe will be assumed in offering the loan to that particular customer. This risk is determined (but not limited to) some of the following factors: the number of years the owner has lived in the home, the amount of equity owned in the home, the amount of the loan, the home location, how much money the bank made or lost in the previous quarter, credit rating of the loan applicant, length of the loan, etc. The volatility of all of these factors impact how the Prime Interest rate and the interest rate offered to consumers are determined and are the reason why, at times, the interest rates set by the “Fed” will head one direction while the Prime Interest Rate will head another.

For the majority of us “average Joe’s”, treating the interest rates set by the “Fed” as a barometric tool to determine where mortgage rates are headed rather than using them as a defacto guide for the determination of mortgage interest rates themselves, is a better way to view the Fed’s changes because as far as the big picture is concerned, they basically follow the same path. For those who would like a more accurate snapshot of where mortgage interest rates stand and do not have instantaneous Mortgage Bond Market access, the 10-year Treasury Yield (readily available at CNBC, WSJ, Bloomberg, etc) is an acceptable albeit not instantaneously accurate gage for finding where mortgage interest rates lie.

Points are Interest → 1 Point = 1% Interest

Somebody created this idea to make things even more complicated. Points are used by mortgage lenders and mortgage brokers in a couple different ways: they can be offered for purchase to lower the interest rate on a mortgage, they can represent the commission charged by a loan broker with the percentage amount in dollars added to the final cost of the mortgage, or they can stand for additional charges added to a loan for persons who might not have stellar credit or who may only have enough cash for a small down payment. Points are nearly always paid at closing in cash.

In the condition where Points are offered for purchase to lower an interest rate the “point” which costs the consumer 1% of the total loan cost will typically only reduce the interest rate by .25%. The trick with point purchasing is to find the balance between the cost of the points purchased and the effect the interest rate reduction will have on the total cost of the loan to see if the point purchase is cost effective. Those folks who have more available cash up front may choose to purchase points rather than make a large down payment because they may be more interested in a lower monthly payment than decreasing the overall cost of the loan.

There are many factors that should be taken into consideration when considering a point purchase, including but not limited to:

  • The tax level of the individual(s) considering the point purchase; for income tax purposes of some individual(s), adjustments to the interest rate paid on a mortgage may not be beneficial. An accountant should be consulted.

  • The length of time anticipated that the individual(s) will posses the home. There is a breakeven point where the amount paid up front to buy points becomes cost effective as compared to what the mortgage cost would have been without the point purchase. The following link: Point Purchase Breakeven Periods will take you to a website that has many calculators showing this information for different interest rate and point combinations. Make a selection from the options found under the “Mortgage Points & Fees” section for the appropriate scenario you desire. Selling the home prior to this breakeven point will negate any savings.

Having the point cost included into the final loan amount is not really an ideal (but often unavoidable) situation as the interest accrued on this amount over the term of the loan will often negate any savings. Most lenders have a point cap on the number of points allowed for purchase.

* – The basis upon which the Federal Reserve makes these judgments is far beyond the scope of this document. For more information on this subject, please see the Federal Reserve website.

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We are not mortgage professionals nor do we claim to be. All information on this site is provided for informational purposes only. Individuals should always consult a real estate attorney prior to making any real estate commitments which they may not understand.