Contrary to popular opinion, interest rates for mortgage loans are not set by the Federal Reserve Bank. This assumption, however, is understandable given the uproar one tends to see in the media every time the Chairman of the Federal Reserve makes any mention whatsoever about raising or lower rates. Of course, you should understand he is discussing the rate that will be charged by banks to borrow from other banks. Interest rates on mortgages, on the other hand, are set by the bond markets among other indicators.
Since bond markets move every business day, the mortgage rates move in a corresponding matter. Even a tiny change can impact how much or little money a lender will recover given an assumed payback of a 30-year loan. To protect yourself from these fluctuations, you must understand how to lock in the interest rate on your loan.
A mortgage cannot be finalized until the interest rate is locked. If you don’t address the issue with the lender, the rate can move up or down every day from application to the actual funding of the loan. This can literally be two or three months if you are getting pre-approved before making an offer on a home. This kind of volatility is dangerous, particularly if you are pushing the limits of your cash flow in buying a home. If rates increase half a percent while you are shopping, you may be unable to make the monthly payments when you finally buy the property of your dreams!
Locking in a loan is all about points and the length of the lock. These issues are negotiable with the lender, to wit, there is no legally required standard. To lock in a rate, you often must agree to pay a percentage of points. The longer you want to lock in the rate, the more you pay. For a 30 day period, you can expect to pay a quarter to a half of a point. For a longer period, expect to pay half to a full point. A point is one percent of the total loan. If a lender tries to charge you more, take your loan elsewhere or get a mortgage broker involved.
Fluctuating interest rates are dangerous since they can impact your month payments. Locking in your rate gives you a definitive figure to work with when buying your dream home.
Many people took out adjustable rate mortgages during the Great Housing Bubble. After 25 years of steadily declining interest rates, people forgot about, or never knew about the risk of rising interest rates and what it would do to their housing payments. Adjustable rate mortgages are great while interest rates are declining. Their payments are lower than fixed rate mortgages, and as interest rates decline, they become an even better deal. However, when interest rates go up again, these loans will become a nightmare.
Interest rate on most adjustable-rate mortgages is lower than those for fixed-rate mortgages because the lender is not subject to interest rate risk. If interest rates rise, lenders who have issued fixed-rate mortgages have capital tied up in below-market mortgages. With adjustable rate mortgages, higher interest rates are passed on to the consumer.
The Option ARM is a hybrid adjustable rate mortgage with payment options. The interest rate being charged to the borrower is subject to periodic fluctuations with changes in market interest rates similar to other adjustable rate mortgages. The timing of adjustment and limits therein are contained in the mortgage contract.
The interest rate charged is fixed for certain periods at the end of which there is a change in the interest rate. When the interest rate changes on most adjustable rate mortgages, the payment required of the borrower changes as well. Since the charged interest rate and the payment rate are not the same for Option ARMs, the payment may not be affected and negative amortization can occur (the loan balance gets bigger.)
Since the low payment option on Negative Amortization loans is so appealing to consumers, the actual interest rate charged on Option ARMs is often higher than interest-only or fixed rate mortgages, which make these loans very attractive to investors.
Since the interest rate is higher than the payment rate, negative amortization occurs, and the loan balance grows each month as the deferred interest is added to the loan balance. This capitalized interest is recognized as income on the books of mortgage holders. Generally Accepted Accounting Principles (GAAP) allow this, but the amount of income is supposed to be reduced to reflect the likelihood of actually receiving this money. Since the loan program was new, and default rates were low due to the bubble rally, the reported income was very high making these loans even more appealing to investors.
From the investors' perspective, they were buying high-interest loans with great income potential and low default rates. From the borrowers' perspective, they were obtaining a loan at a very low interest rate, a perception rooted in a basic misunderstanding of the loan terms, and a very low payment which allowed them to finance large sums to purchase homes at inflated prices. This dissonance between the investors who purchased these loans and the borrowers who signed up for them did not become apparent until these loans began to reset to higher rates and recast to higher payments.
In short, these loans are time bombs with fuses of varying lengths set to blow up the dreams of investors and borrowers alike.
During The Great Housing Bubble these loans were widely used, and when borrowers began defaulting on these loans, a massive credit crunch ensued that sent the world economy into recession.
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Dan Lewis has sinced written about articles on various topics from Mortgage, Finances and Business and Finance. Dan Lewis is with Great Western Mortgage - provided by San Diego Mortgage Brokers. Great Western Mortgage is a. Dan Lewis's top article generates over 18100 views. to your Favourites.
Alex Gwen Thomson has sinced written about articles on various topics from Home Management, Income Tax Return and Wrinkles. is the author of The Great Housing Bubble: Why Did House Prices Fall?Learn more and get FREE eBooks at:. Alex Gwen Thomson's top article generates over 673000 views. to your Favourites.