The main topic of discussion by anyone seeking a mortgage loan is "What's the interest rate"? Arguably this one little number has the greatest affect on your payment amount and whether or not you can afford the home you wish to purchase.
Did you know there are many people out there that could not tell you what interest rate their mortgage has on it? Sad but all too true, most people never take the time to look let alone figure out why they are being charged at a particular interest rate.
But what exactly is the interest rate? Where does it come from? Who decides the amount? Why does it fluctuate almost daily? And why does it affect the amount of mortgage being paid for?
All of these questions are very relevant and you should be asking them in order to completely understand your mortgage loan and why you received that particular rate. The interest rate affects the payment amount and the rate at which the principal is paid off.
What is the interest rate?
This is the amount or percentage of "fees" the bank or lender charges for loaning you money. The rate is based upon several factors
- The type and length of loan – Fixed rate, variable rate or interest only loans. 10 year, 15 year, 20 year, 30 year or even 40 year terms.
- Credit history of the applicant – the better your credit, the less of a lending risk. The worse off your credit, the higher the loan risk and hence a higher interest rate.
- Prevailing rate from the Reserve Bank of Australia – The entity that sets the national interest rate or prime lending rate to banks and other lenders.
There are a few lesser concerns which may affect your interest rate, such as how your income is derived and if this is your first time purchasing a home. The biggest factor is your credit history.
Where does it come from?
Interest rates are set or determined by the Reserve Bank of Australia – A central bank responsible for monetary and financial system policies and is accountable to Parliament. The main purpose of the RBA is to control or limit inflation over a medium term. It raises or lowers interest rates according to the economic indicators and recommendations from Parliament. This in turn keeps inflation from manifesting itself and causing an economic recession.
In other words, the Reserve Bank of Australia determines the "fee" for banks and other lenders to borrow money in order to keep a lid on prices.
The daily fluctuation is due in part to the market trends and the laws of supply and demand. If the housing industry is experiencing a "glut" or over abundance of homes for sale; interest rates will go down to help spur on sales. If the number of homes for sale is inadequate to meet demand, interest rates will rise in order to slow down the number of home buyers.
The reason why Interest rates affect the size of the home you can afford is simple – The higher the interest rate, the higher the monthly payments. Example:
$100,000.00 loan at 5.75% Interest Rate for 30 years = $583.57 per month $100,000.00 loan at 6.75% Interest Rate for 30 years = $648.75 per month $100,000.00 loan at 8.00% interest rate for 30 years = $733.76 per month
As you can see, the interest rate greatly affects the monthly payment amount – If you can't afford a $150.00 more a month, then you will need to purchase a less expensive home. Often times it is the interest rate that precludes the purchase of a home, not the amount of down payment.
Why else should you be informed about Interest Rates – To make sure you are receiving the best rate for your loan. If you are unaware of the current rates being offered, you could be charged for a higher amount. There are unscrupulous entities that will try to take advantage of the unsuspecting or the uninformed.
If you feel you are being charged an inappropriate or unfair interest rate, find out why. It could be due to something on your credit history or some other factor which may cause you to be considered a higher risk. All you have to do is ask.