For many potential homebuyers, the decision to purchase a property has been on hold, with the hope that interest rates will drop significantly. Some people claim that the Federal Reserve hasn’t adjusted rates all year, while others note that rates have fluctuated.
In this post, we’ll explore why these viewpoints might seem contradictory. We’ll break down how interest rates are set, examining both governmental policies and personal factors. By understanding these dynamics, you’ll gain insight into how your own financial situation can influence the rates you encounter.
GOVERNMENTAL FACTORS INFLUENCING INTEREST RATES
To understand interest rates, we need to start with the FED fund rate. This is the interest rate set by the Federal Reserve, which is the central bank of the U.S. It’s the rate at which banks borrow money from the Fed.
When banks get money from the Fed, they have to pay this rate. To make a profit, banks then lend money to us at a higher rate. The difference between the rate banks pay the Fed and the rate they charge us is called the spread. This spread is our first key factor in how interest rates are set.
The Spread
The spread is the difference between the interest rate that banks borrow from the Federal Reserve and the rate they charge you. As of June 25th, 2024, the FED fund rate is 5.5%. This rate has been steady at 5.5% for the entire year, up from 5.25% previously.If banks borrowed money from the Fed at 5.5% and then lent it to you at the same rate, they wouldn’t be making any profit. Because banks need to earn money, they charge you a higher rate than 5.5%. So, you can expect the rates you see to be higher than the FED fund rate.
The Bond Market
Another important factor is the bond market. The bond market helps determine where loan rates fall on a spectrum—from low to high. When the bond market is doing well, loan rates are closer to the FED fund rate. But if the bond market is struggling, loan rates tend to be higher.If investors lose confidence in bonds or the economy, they might push rates higher to make more money quickly. So, if there’s a lot of uncertainty or volatility in the bond market, you can expect higher loan rates.
- Historical Trends
Historically, when investors are confident and excited about the stock market, they’re less likely to invest in bonds. Bonds usually offer lower returns but are safer and less volatile compared to stocks. When the stock market is doing well, people often prefer to invest in stocks instead of bonds. This can lead to the bond market performing poorly, which tends to push up loan rates. Speculation and News
When the FED announces plans to cut rates, it can make investors more confident and lead them to invest more in the bond market. This often results in better loan rates. Conversely, if the FED announces that there won’t be any cuts or that rates might go up, the market might react negatively. While there are other factors that can affect this, we’re focusing on the basic ideas here.
PERSONAL FACTORS INFLUENCING INTEREST RATES
As of today, depending on the lender you use and what closing costs you’re willing to pay, which includes points and origination fees, you’re somewhere between 6.5% and 7.125%. However, there are five factors that affect this, and rates can vary higher depending on those factors:
- Credit Score
Your personal credit score will have a dramatic effect on your rate, especially on the conventional level. - Credit History
A high credit score with limited credit history may restrict your ability or lead to a higher risk, affecting your rate. - Debt-to-Income Ratio (DTI)
This is the percentage of your income that goes towards debt servicing costs. A lower ratio is preferred. - Loan-to-Value Ratio (LTV)
This refers to the down payment amount. For example, if you’re buying a $500,000 property and putting down 40%, you’ll generally have a better rate compared to putting down 5%. - Type of Loan Product
Different loan products have different interest rates. For instance, investment properties may have higher rates compared to primary residences. FHA and VA loans also have different rate structures compared to conventional loans.
CONCLUSION
- Whether the FED raises rates or not, the rate can still fluctuate.
- Shop around because different banks offer different deals.
- Consult with a real estate professional to guide you through this process.
If you’re considering buying a home or investment property, reach out to us. We can discuss current rates, how rules vary, and help with cash flows and other ways to make money in real estate. Reach out by calling (678) 389-3887 or email us at [email protected]. Get a free consultation about your property!
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