We heard a radio commercial the other day that the mortgage interest rate is now the second lowest in history. Given the fact that it’s possible to get a mortgage with an APR as low as 3.501% this left us wondering what could have been the lowest interest rate ever?
It’s difficult to imagine that interest rates will go much lower but here’s the bad news. Some experts say that many banks are not giving people the lowest rates that they should. The reason for this has nothing to do with the borrowers. It’s how the banks price their mortgage loans. While you might think you’re getting your mortgage from a bank or some other lender, the fact is that it will ultimately be sold to an investor that buys mortgage loans from banks. You can’t control the fact that your lender wants to make a profit when he sells your mortgage but there are some other things you could do to ensure you’re getting the best possible mortgage interest rate.
More than 90% of the mortgages that are sold after they close are purchased by investors such as Freddie Mac, Fannie Mae and the Federal Housing Administration (FHA). The reason why your lender sells your loan so they will have more money available to lend and to eliminate the risk if you were to default. If they want to sell their loans they must offer mortgages with terms and rates that make them attractive to the investors. This means that mortgage interest rates are controlled more by the investors than by the banks.
Hedging against the short-term rates
There’s little room for mortgage originators to pad interest rates because the industry has become so competitive. The one exception to this rule is what are called “jumbo loans” or mortgages typically for $417,000 and higher. Lenders hang onto these loans because Fannie and Freddie won’t buy them and because they want to keep a relationship with the affluent clients that get them. In this case, the lenders may be inflating the interest rate a little bit as a hedge against a time when short-term rates do begin to increase. This can also help them protect their profit margin on low interest rate loans.
Not passing on the savings
According to one expert, many of the “jumbo” lenders are borrowing money from the Federal Reserve and other such sources at 0.25 to 0.50% but failing to pass the savings on to their customers. The president of Approved Funding in River edge, New Jersey pointed out that there are two other times when banks may choose to hedge their rates a bit. The first of these is when a lender has locked in an interest rate that’s lower than the rate that’s prevailing now. The other is when the bank is trying to manage mortgage demand so it can clear a backlog of loans without having to add more people to handle the additional volume.
There may be nothing you can do about the bank’s profit margins or how Freddie and Fannie influence mortgage rates but there are two things you could do to ensure that you’re doing everything you can to get the best mortgage interest rate possible.
The first of these has to do with your FICO score as mortgage interest rates vary based on the borrower’s score. You could have a score of 740 and would not be any more likely to default than someone with a score of 760 but you will have a higher interest rate. Given this, it’s important for you to know where price breaks fall on the FICO scale as this could help you get a significant discount. As an example of this, let’s suppose that your bank’s discount kicks in at a credit score of 700 and yours is 680. In this case, you might be able pay down a couple of credit card balances or pay off a personal line of credit, which would jump your score up to the next level.
The second, has to do with discount points. If you’re not familiar with them they are a one time, upfront closing cost that gives a borrower access to “discounted” interest rates as compared to the market rate. Each discount point usually costs 1% of the total amount of the mortgage. So the discount on a $300,000 mortgage would be $3000. A point paid at closing will usually lower your mortgage rate by 25 basis points or 0.25%. These points can be tax-deductible because the IRS counts them as prepaid interest.
Be sure to shop around for your mortgage as different banks will offer different discounts in exchange for points. In the example given above each point was worth 0.25%. However, paying two points may or may not lower your interest rate by 50 basis points or 0.50%. Be sure to ask each lender to quote you an interest rate based on zero discount points so that you’ll be comparing apples to apples and not apples to coconuts.
If you’d like more information about mortgage interest rates, points and discounts, here’s a video that explains things in plain, simple terms.
Frequently Asked Questions about mortgages
Q. What mortgage interest rate can I expect?
A. As pointed out in this article, your interest rate will depend on several factors, the most important of which is your FICO score. Beyond this there are a whole bunch of factors that will influence your interest rate. Most experts say that the movement of the 10-year Treasury bond yield is the best gauge of whether mortgage rates will go up or down. If you’re shopping for a mortgage one thing you could do is watch what happens with 10-year Treasury bond yields so, you’ll know whether interest rates are about to go up.
Q. Where our mortgage rates headed today?
A. Given the fact that it’s possible to get a mortgage with rates as low as 3.501%, it’s hard to imagine they will go much lower. If you’re thinking about buying a home or refinancing your current mortgage, now would be a good time to act because mortgage rates are likely to start edging up.
Q. Why are mortgage rates and the APR different?
A. The mortgage interest rate is its interest rate. Its APR includes other costs such as the broker’s fee, the aforementioned discount points and some closing costs. It is also expressed as a percentage. A mortgage could have an interest rate of 4.5% but an APR of 4.619%. The best way to look at this is that the true cost of a mortgage loan is not its interest rate but its APR.
Q. Why are mortgage rates so low?
A. This gets a bit technical. Mortgage rates have dropped primarily because the federal reserve has reduced its involvement in the market for mortgage-backed securities by $35 billion monthly over the course of the last nine months. In addition, it is planning to terminate QE3 (quantitative easing) with a final reduction of $5 billion later this month.
Q. Who pays for mortgage insurance?
A. The purpose of mortgage insurance is to reimburse the lender should you default on your loan. If you put down less than 20% you will probably be required to pay for this insurance. If you buy it from a private company, it’s called PMI. Its cost will be included in your total monthly payment, at time of closing or both. If yours is an FHA loan you will definitely be required to buy mortgage insurance and you will pay for it to the FHA.
When is a mortgage in default?
A. Mortgages are not considered to be in default. They go into in foreclosure. Your lender has the right to call the loan and begin foreclosure proceedings if you miss just one month’s payment. However, in reality, most will not call a loan until you are three months’ delinquent.