Introduction

If you’ve ever heard friends or family in your life talk about buying a house, you’ve probably heard the term “mortgage rate.” But what does this really mean, and why is everyone so concerned about it? To help, we’ll break down the basics of mortgage rates (in a way even a middle schooler can understand) and walk through how they work, what affects them, and what they mean for the overall cost of a home. Finally, we’ll explore some creative ways to get around high mortgage rates if you’re looking to buy a house.

What Are Mortgage Rates?

A mortgage is basically a big loan you use to buy a house. Since buying a home often costs hundreds of thousands (or even millions) of dollars, most people don’t have that kind of cash lying around. Banks and other lenders step in to lend you the money, and in return, you pay them back over time with interest.

  • The “Rate” Part: A mortgage rate is the percentage of interest you have to pay on top of the money you borrow. Think of it as the “extra fee” your lender charges you for letting you use their money.
  • Why It Matters: The higher the interest rate, the more you’ll pay back overall. A 1% difference in your mortgage rate can add up to tens of thousands of dollars over the life of your loan.

How Mortgage Rates Work

A mortgage payment generally consists of:

  1. Principal: The amount you borrow.
  2. Interest Rate: The annual rate your lender charges to lend you the money.
  3. Loan Term: Commonly 15 or 30 years (or 180 and 360 monthly payments, respectively).

Each month, your mortgage payment chips away at both the principal (what you borrowed) and the interest (the lender’s fee). Over time, your debt shrinks—though how quickly it shrinks depends heavily on your interest rate. In an article next month, we’ll break down how to calculate your total mortgage costs, monthly payments, and how much can be saved with lower interest rates.

What Causes Mortgage Rates to Move?

Mortgage rates may seem like they change for mysterious reasons, but they’re actually influenced by a variety of economic and market factors.

  1. Federal Reserve Policy: When the Fed adjusts interest rates (like the federal funds rate), it often influences mortgage rates indirectly. However, the 30 year mortgage rate tends to track more closely to the 10-year treasury note rate, illustrated in the image below from Fannie Mae. So while Federal Interest Cuts often lead to a drop in mortgage rates, that may not happen if the 10-year treasury rate doesn’t also drop.
  2. Inflation: When prices rise generally, lenders demand higher rates to ensure they still make a profit over time.
  3. Economic Growth: In a strong economy, more people want mortgages, pushing rates higher.
  4. Housing Market Demand: If lots of people are buying homes, demand for mortgages goes up, which can lead lenders to increase rates.
  5. Investor Appetite for Mortgage-Backed Securities: These are bundles of mortgages sold to investors. If investors are hungry to buy them, rates tend to go lower (and vice versa).
10 Year Treasury vs Mortgage Rates

Mortgage rates are primarily driven by economic forces and investor behavior, with the 10-year Treasury bond acting as a pivotal benchmark. Although the Federal Reserve doesn’t directly set mortgage rates, its policies shape the broader interest rate environment. Inflation expectations, economic conditions, and bond market demand all play a role in how much you’ll pay in interest when buying a home. All of these will be looked at further in an upcoming article.

Creative Ways to Handle High Mortgage Rates

When mortgage rates spike, it can feel discouraging to jump into the housing market. However, there are several strategies that can help you lower your monthly payment or reduce your total costs in the long run. Below are both standard solutions and some more creative ones:

a) Refinancing Later

  • The Standard Approach: If you get a mortgage now at a higher rate, you can refinance (replace your old mortgage with a new one) when rates drop in the future.
  • Why It Helps: Refinancing can lower your monthly payment and save you money in interest over the life of the loan.
  • Downside: Often costs money to refinance, ranging from 2% – 6% of the loan amount. So just make sure to run the calculations to ensure you’ll still be saving money in the long run.

b) Buy Down Your Rate (Mortgage Points)

  • What It Is: Mortgage points are fees you pay to your lender upfront to secure a lower interest rate.
  • Who Benefits: If you plan on staying in the home for a long time, buying points can be a smart move since it reduces the interest you’ll pay over the loan’s life.
  • Downside: Requires more money upfront, which is already a struggle, especially for first time homebuyers with no equity from a previous home.

c) Opt for an Adjustable-Rate Mortgage (ARM)

  • How It Works: An ARM typically offers a lower fixed rate for an initial period (e.g., 5-7 years) before adjusting periodically.
  • Best For: People who don’t plan to stay in the home for many years or expect rates to drop before the adjustable period kicks in.
  • Downside: Mortgage rates could also increase, leading to risk of paying more.

d) Consider a Shorter Loan Term

  • 15-Year Mortgage: Although monthly payments are higher, the interest rate is generally lower than a 30-year mortgage, and you pay less total interest.
  • Balance Your Budget: Make sure you can comfortably handle the higher monthly payment before choosing this route.
  • Downside: Larger monthly payments could be a risk for people who are already “house poor”, or basically paying a large percentage of monthly income to the house.

e) A Bigger Down Payment

  • Why It Helps: The more money you put down, the less you need to borrow. This often means lower interest rates because you’re considered a lower risk to the lender.
  • Downside: Similar to a few of the above options, many homebuyer’s may struggle to even hit the recommended 20% down payment if they do not have any home equity or previous savings.

f) Seller Financing or Lease-to-Own Agreements

  • Creative Options: Sometimes, the seller might be willing to finance part (or all) of the loan themselves, potentially at a more favorable rate.
  • Lease-to-Own: Another arrangement could be to rent the property with an option to buy. This gives you time to improve your credit or wait for better mortgage rates.

g) Co-Buying or House Hacking

  • Partner Up: Consider buying a home with a trusted friend or family member to share the cost.
  • House Hacking: Renting out a room or portion of the property to help offset your mortgage payments. This approach can effectively lower your living expenses.

Conclusion

Mortgage rates might seem mysterious or complicated, but understanding the basics can help you make informed decisions when buying a home. They affect how much money you’ll ultimately pay back to the lender, which is why borrowers are always looking to secure the lowest rate possible. While rates do move up and down based on economic factors, you still have plenty of control over how you structure your loan—through refinancing, paying points, or exploring creative financing options.

Whether you’re a first-time homebuyer or simply looking to upgrade, the key is to do your homework, weigh your options, and make a choice that suits both your financial goals and personal situation. With the right strategy, you can navigate even the most challenging mortgage rate environment and still achieve your dream of homeownership.