2022 has brought some record breaking prices to the Arizona housing market. And now, to top it off, home loan interest rates are on the rise. Rates not only impact your monthly payment, but also the money you’ll pay out in interest over the life of the loan. If you’re a first-time homebuyer trying to figure out how to buy a house, odds are you should know a thing or two about home loan interest rates.
Home Loan Interest Rates Explained
If you didn’t already know, houses are expensive. In the Phoenix area, the median home prices have increased by 31.3% in the past year. As of March 2022, it sits at $440,000. With those stats1, it’s extremely difficult to purchase a property with cash if you're not already an investor—it’s almost unheard of. If you’re like us, chances are you will need to borrow money from a financial institution to buy a house.
By taking out a loan, you are responsible for paying back that loan monthly, in smaller payments, until you have paid off the entire house. As an exchange for borrowing the money, the financial institution who lent you the funds will require the full amount back that you borrowed, plus extra in the form of interest.
Interest is what we must pay in exchange for borrowing money. A home loan interest rate is the annual rate at which we are charged. For example, let’s say you are buying a house for $450,000. You decide on a 30-year-fixed-term, and let’s assume you have some money saved up and can apply a $18,000 down payment. Your down payment is the way you start paying back that loan amount. Then, as the months continue, you'll be paying remaining loan amount (the principal) plus interest on the outstanding amount per year. Let’s do the math for a 5% home loan interest rate:
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Yikes. That kind of cash isn’t just laying around the house. Don’t forget about factoring in taxes, home insurance, private mortgage insurance, and homeowner’s association fees. On the bright side, this is just an example! You have many different options when it comes to financing a house. You can choose a term that works for you, a different type of mortgage, and you may be able to qualify for down payment assistance (like the WISH program) depending on your situation.
Even in this scenario, the grand amount of $834,864 would be spread out over the course of 30 years. So, you would end up paying $2,319 a month, for 360 months. The great news is that you can always pay more than the required monthly amount. Some people like to make a 13th payment every year instead of just 12. Others enjoy bumping up their monthly payment instead, like $50 or $100 extra dollars per month to your mortgage payment. Strategies like these can definitely help you pay off the house quicker and save you quite a bit in interest.
If you have a better idea of what house prices, home loan interest rates, and down payment funds look like for you, then run the numbers for yourself! Here’s a calculator to help you out:
How Are Home Loan Interest Rates Determined?
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As you can guess, the lower the home loan interest rate is, the less money you have to pay your financial institution.
So, how do these financial institutions even come up with these numbers?
Long story short, there are several different factors. But, most of the time, the Fed is who gets the ball rolling. The Fed or Federal Reserve System2 is our central banking structure here in the United States. It was created to keep a safe, flexible, and stable monetary system.
The Fed is in charge of:
- Supervising banking institutions
- Providing financial services
- Influencing monetary & credit conditions such as home loan interest rates
- And many more duties
The Fed doesn’t just come out and say “here are the new home loan interest rates.” Basically, what happens is that the Fed will determine this thing called the federal funds rate. This is the interest rate that financial institutions have to pay when they borrow money from each other. So, whenever the Fed raises this interest rate, banks and credit unions will have to pay each other more in interest. Thus, these financial institutions directly raise their home loan interest rates to remain economically secure. If you’re interested, you can see a chart of all Fed fund rate changes.
What Makes Home Loan Interest Rates Fluctuate?
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Inflation:
When inflation goes up, home loan rates tend to go up. Even a modest uptick in the overall cost of goods and services has a ripple effect on other aspects of the economy. Lending institutions track inflation carefully. Interest rates tend to keep pace with inflation in order for institutions to remain financially stable. As of Spring 2022, the annual inflation rate has increased to 7.9%, the highest it's been since 1981.3 -
Economic Growth:
When GDP (the country’s gross domestic product) and employment rates are both up, home loan interest rates often grow. When these two indirect forces are strong (GDP and employment) it informs lenders to anticipate an increase in demand for loan products. That’s when it makes sense for lenders to charge higher rates for their limited supply of mortgage loans. -
Bond Market:
As U.S. Treasury note rates rise, current mortgage rates go up. Why? They’re competing for the same type of investor (you!). Buyers of both want a low risk and stable return. -
Housing Market (a.k.a. the surprisingly sunny side of rising rates):
The state of the Arizona housing market can impact home loan interest rates as well. Clearly, a higher rate will cost more than a lower rate over time. But an uptick in rates can have other (beneficial) consequences due to the rate/home price paradox:
When there aren’t that many homes on the market, but many buyers want them, sellers often increase listing prices. But this usually corresponds with lower rates! You can enjoy a lower monthly premium and quicker impact on the principal due to that low rate.
On the other hand, when there are several homes on the market and less people ready to buy, the prices of homes tend to be lower. Home loan interest rates may be higher, but this could still offer a unique benefit— you may be able to shorten your term and pay less interest overall because of the lower principal amount of the loan.
How Home Loan Interest Rates Impact Affordability
Unfortunately, in 2022 and especially in Arizona, we're stuck with both high prices on homes and rising interest rates (trying to slow inflation). Here's some more info.
Let’s start by talking loan basics. When you purchase a loan product, it’s likely that the interest will be amortized over the entire life of the loan. Basically, this means that a higher percentage of your monthly payment goes toward paying interest during the first portion of your loan term. This tends to result in lower home equity in the early years of a mortgage. (What is home equity? Click here to find out more.)
Here’s an example:
On a $500,000 mortgage loan at 4.5% APR over 30 years, your initial payments (Principal + Interest) are around $2,500/month. 74% of this initial payment amount is going towards interest, and the total interest paid over the life of the loan would be approximately $412,000.
With the same loan and same term at a lower rate, say around 3.5%, you’re looking at an $2,245 monthly principal + interest payment, with only 65% of the initial payment amount going towards interest. This would result in $104,000 less interest paid over the life of the loan! Even a 1% rate difference matters. Check out this amortization calculator if you want to run the numbers yourself.
Interest rates may also impact how much home you can afford - or be approved for - overall. It's best to talk with a mortgage specialist to get more info on your specific situation. Plus, you can always use house buying checklists and read up on tips that can help for first-time homebuyers.
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Even though home loan interest rates may feel daunting, you can always make adjustments to improve your situation. As you venture off to find your new home, you may want to check out the best neighborhoods in Phoenix. Happy home buying!
Sources
1 https://www.redfin.com/city/14240/AZ/Phoenix/housing-market
2 https://www.investopedia.com/terms/f/federalreservebank.asp
3 https://www.statista.com/statistics/273418/unadjusted-monthly-inflation-rate-in-the-us/
This article is intended to be a general resource only and is not intended to be nor does it constitute legal advice. Any recommendations are based on opinion only. Rates, terms and conditions are subject to change and may vary based on creditworthiness, qualifications, and collateral conditions. All loans subject to approval.
