Interest Rates – A Better Understanding
Real estate lingo. We know you probably don’t geek out on it like we do. We get it! At Anne Warren Homes, we want to help boost your confidence when it comes to talking the talk. It’s almost like you need to learn a whole new language when you get ready to buy a house. New phrases, acronyms added to your personal dictionary. You know the ones- DTI (debt- to – income ratio), PMI (private mortgage insurance), equity, escrow… the list goes on and on. We understand that the terms associated with home buying can be overwhelming in the beginning. This is why we think it’s imperative that we help you make sense of it all, helping you start that home search with a positive self-position when it comes to those conversations that are inevitable. When it comes to mortgages, loans, interest rates, financing, it is crucial that you are informed when deciding the best fit for you. Working with an experienced real estate professional can help ease the process.
WHAT IS AN INTEREST RATE?
The term “interest rate” is something you’ve most likely heard. It’s popular lingo for many financial processes and situations. From credit cards to car loans, everyone is talking about interest rates! But what is an interest rate? For you, the potential borrower, an interest rate is basically the amount that you are charged for a loan. Another way to put it, is that you are paying to use someone else’s money. Interest is generally shown as a yearly percentage in terms of a loan. The amount that you’re borrowing is called the principal. In a formula that doesn’t include the APR (annual percentage rate) a simple breakdown could look like this:
You take out a $200,000 mortgage at a 4% interest rate over the term of 30 years. If you take the principal (remember – the amount borrowed) $200,000 and multiply it by the interest rate you get, which is 4% we get this simple equation: $200,000 x 0.04% = $8,000. So you’re paying $8,000 in interest over those years as a payment for borrowing the money. Naturally, if your interest rate is higher, you pay more for the money. When the rates are low, our economy booms because people are spending more, because they are paying less to borrow money.
For financial institutions that lend money, this is a way to offset the risks of loaning out money. It helps insure they are safe against loss if someone doesn’t make their payments, as well as earning a profit for their loans. However, it’s not just the bank or lender that decides the current interest rate.
WHO SETS INTEREST RATES?
There are several factors and influences that affect the interest rates. The major deciding entity is the Federal Reserve, which is the central banking system of the U.S. The Federal Reserve sets the Federal Funds Rate (the interest rates that banks can charge each other for loans they need to meet their individual requirements). The Federal Reserve has set parameters for this amount, but it can go up and down from low to high ends. This information then influences factors that lenders use as a guide when determining loan interest rates. If the number goes high, then loans may be more expensive, depending on when you try to borrow money.
HOME INTEREST RATES / MORTGAGE RATES
As a potential buyer in the Greater New Orleans Area, you may be pondering home loan interest rates. When you’re trying to make sense of it all, it’s helpful to know that a mortgage rate is the actual interest rate on your home loan. Since there are many options available, that also means that interest rates also vary. The main two we see are fixed and adjustable interest rates. These describe the way the interest rate is applied to your loan. With either, they are usually amortized, which is a fancy way of saying that homebuyers pay the interest rate back in a larger ration in the beginning, and pay the principal (Pop quiz: do you remember what this means? If you answered the amount you want to borrow, you’re correct!) toward the end of the terms.
FIXED-RATE MORTGAGES
In a fixed rate home loan, the interest rate stays consistent throughout the entire life of the loan. This is a benefit to the borrower because there are fewer surprises, making budgeting easier. Another positive is that even if the market changes, your interest rate won’t be impacted. Generally, homeowners choose a fixed rate mortgage of 10, 15, 20 or 30 years with most choosing a 30 year fixed rate mortgage, according to popular mortgage company Freddie Mac.
ADJUSTABLE-RATE MORTGAGES
While not as popular as the aforementioned, an adjustable rate mortgage can see the interest rate rise and fall in response to other factors. People that choose this type of mortgage tend to be investors or those who are comfortable with fluctuations in interest rates. The main benefit to this type of mortgage is that if the interest rates fall, you won’t have added fees to refinance at a better rate. These also tend to start at a lower rate but after an initial fixed period, rates may change.
UNDERSTANDING APR
One thing that is important to consider when it comes to the total amount you’ll pay is the APR, or annual percentage rate. The interest rate helps you figure out how much you will pay each month, but the APR shows you other things you may need to pay, like closing costs, discount points, mortgage insurance and loan fees.
PROTECTION FOR BUYERS
We get it! From the outside looking in, sometimes it seems like a complete free for all. Insert Oprah: “You get an interest rate! And you get an interest rate! And you get an interest rate!” However, lenders can’t just pick any interest rate. There are actual laws in place, referred to as usury laws, put there to protect both borrowers and lenders. These laws ensure that lenders can’t overcharge fees, depending on the type of loan. In Louisiana, the maximum usury amount is an interest rate of 12% per year.
PERSONAL HISTORY AND HOW IT APPLIES TO INTEREST RATES
If you’ve ever taken out any loan you understand that your personal credit history impacts your interest rate. With a higher credit score, a lender will feel more confident in your ability to repay a loan, and they will most likely offer you a lower interest rate. A lower credit score generally does the opposite. Researching your options, asking lots of questions from experts, will always help you decide the best option for your situation and how interest rates will impact your loan.
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