Just this week the Federal Reserve lower the federal funds rate 0.25% to a target range of 1.75-2.00%. This rate is how much a local bank can borrow money from the Fed and then re-lend to consumers. So, that does ¼ of 1% mean to you as a home buyer in a lower interest rate charged?
The interest rate is the amount of money the bank charges you for borrowing the money to pay for your home. The principal of the loan plus the interest rate determines your monthly mortgage payment. With a fixed-interest loan, your total amount is divided by the length of the loan, and then again by 12 monthly payments. Even a .25 percent difference in your interest rate can add to your monthly payment depending on your loan amount. That number increases even more over the life of the loan.
If you are a first time home buyer, you have lots of things to consider. What part of town do you want to buy a home in? Is your credit good enough? How much of a house and what kind of payment can you afford? Your home will likely be your biggest investment in life, and it will impact all your future investment decisions.
Unless you pay your insurance and taxes directly (which most banks will only allow if you have a substantial down payment), your payment will include principal, interest and escrow payments to cover taxes and insurance. You can't control the principal or taxes, but you can shop for insurance and your interest rates.
Interest Rates
A bank or mortgage company will determine the interest rate you are charged based on current market conditions, as well as, your personal creditworthiness. The better your finances and credit, the better interest rate you can get on your loan. The interest rates on mortgages are compounded, which means that you're paying interest on the interest that has accrued every month as well as on the principal balance of the loan. This is why even a small change in the rate, although it can seem insignificant, it adds up when you consider the size and length of the loan.
The Payment Calculation
The standard formula for calculating a monthly mortgage payment is M= P[i(1+i) to the nth power] divided by [(1+i) to the nth power - 1]. "M" equals your monthly payment. The “i” is your interest rate divided by 12. The "P" stands for the principal of your loan and “n” is the number of payments, which will vary depending on the length of your loan. By entering different interest rates, you can calculate what different percentages would cost you per month. Now you don't have to get out the spreadsheet, and figure this out yourself. There are numerous online tools to help you calculate a monthly payment based on the term of the loan. Both the Houston Association of Realtors' and the National Association of Realtors' website both offers such online tools.
Doing the Math & What it Means
Just a few months ago, before the Fed initially lowered the Federal Fund Rate by 0.25%, the national average interest rate on a 30 year fixed rate mortgage was 4.2%. Just last week before the latest lowering of rates, the national average was 3.75%. If your interest rate is 4.2 percent on $200,000 of principal, your monthly payment would be $978. When the rate dropped by .25 percent, and the mortgage rates dropped on average to 3.75%, your monthly payment becomes $926. This difference of $52 a month, does not seem like a lot, bit it adds up quickly. Over the 30 years of the loan, the total payment would be $352,092 versus $333,443. With an additional decrease of 0.25% in the interest rate, that payment will decrease to $870/month, with a lifetime payment of $313,349. That means ever 0.25% decrease in interest rate will save about $20,000 over the life of the loan.
If you are thinking of selling, buying or investing in real estate, I would love to help. If you are in Houston, give me a call and me and my team will assist in any way necessary to make your needs a reality. If you are anywhere else in the USA or internationally, I have a worldwide network of affiliates that can meet your needs. And, since we are talking mortgages, if you need help in that area, I can always recommend a few bank officers and mortgage brokers to get you estimates.
Joe Tornberg, JD, MBA
832.236.7671
