Interest Rates

The basics

Let's say you want to buy a house. What do you need to know about bank interest rates?

First you need to know the benefits and drawbacks of the different types of mortgage interest rates that are available. One of the most important features of home interest rates to consider is whether to obtain a mortgage with a fixed interest rate or a variable interest rate.

Fixed Rate

As the name indicates, a fixed rate does not change over the life of the loan. If your interest rate is 7% at the beginning of the loan, it will still be 7% at the end of the loan. The primary benefit of a fixed rate is that you know how much your payment is going to be for the entire time that you are paying on the loan. This makes financial planning and budgeting much easier. The downside to a fixed rate is that, if interest rates decline, you are stuck with the rate you have.

Variable Rate

Variable rates are also known as floating and adjustable rates. A variable interest rate changes (usually annually) during the life of the loan. The initial interest rate is calculated using a base rate plus a margin, also called a premium. A base rate is usually an interest rate that is commonly known to the general financial market, such as the prime rate or the one-year T-bill rate, etc.

The lender adds a percentage to the base rate to determine the actual interest rate you will pay on the loan. For example: If the prime rate is 5% and the bank adds 3% to the prime rate, your actual interest rate is 8%. Now, let's say the prime rate increases to 5.5%. Your actual interest rate increases to 8.5%. Likewise, if the prime rate declines, your actual interest rate will decline by a like amount. Throughout your loan, your interest rate will be 3% above whatever the prime rate is at the time.

There are many variations of combination loans with both fixed and variable mortgage interest rate features. These mortgage loans are fixed for a number of months and then adjust annually for the remainder of the loan. There are even mortgages that require interest only payments for a specified number of months and then begin amortizing with an adjustable interest rate.

The benefit of the variable mortgage interest rate is that you may be able to obtain a lower rate at the beginning of the loan and you take advantage of declines in interest rates. The downsides to a variable home mortgage rate are that it is more difficult to accurately plan and budget your finances because you never know when interest rates are going to change. Also, your rate could increase significantly as market interest rates increase.

Fluctuations in mortgage interest rates are caused by supply and demand in the financial market place. If there is a higher demand for loans, interest rates will rise. If demand for loans declines, interest rates will decline as well.

Demand for loans increases when the economy is expanding and businesses are growing. With more customers wanting loans, banks can be choosy about who they lend to and charge more in the form of interest. When the economy is not doing well and less people are purchasing homes, etc. banks will reduce their interest rate in hopes of enticing borrowers.

To find a lender with low interest rates you will need to research current interest rates in your area. Current interest rates can be found on the web, in the newspaper and by speaking with a representative at your local bank branch.

by Sheila Attebury