If you’ve watched the news recently, you have probably heard that interest rates are at or near historic lows. What you may not understand is why this is important to you. Most people think this only matters to incredibly wealthy people. However, it also applies to you in more ways than you realize.
Think of all the things you pay interest in your daily life. When you start to list it all out, you’ll quickly realize that it’s a lot more than you think. It includes things like:
- Mortgage payments.
- Car notes.
- Credit cards.
- Student loans.
- Personal loans.
The higher the loan and the longer the term (amount of time you’ll be paying for the loan), the more you’ll ultimately pay for those items. When it comes to credit cards, for instance, that often carry as much as 20 percent or more interest rates, paying those off at a lower interest rate can save you decades of payments.
The same holds true for mortgages that typically last 30 years for the average home buyer. We’ll discuss all the benefits of historically low benefits for home mortgages later. What you need to understand is that by reducing your mortgage interest rate, you can pay half what you would for your home at higher interest rates. You may even be able to reduce the terms of your payment so that you pay even less!
Anyone who has been out of school for more than a decade is set to experience huge savings if they choose to refinance interest rates at today’s low rates. The bottom line is that the current low rates are a boon for consumers who may feel as though you are drowning in interest at the moment.
For now, let’s take a deep breath and dig in so you can better understand what historically low interest rates could mean for you.
How to Maximize Historically Low Mortgage Rates
A home mortgage is one of the places where you can see the difference that interest rates make in the cost of your home. While interest rates vary somewhat based on mitigating factors and from one lending institution to another, the current interest rate is somewhere in the neighborhood of three percent for homebuyers with good credit. Sub-prime (borrowers with less than ideal credit) mortgage interest rates, on the other hand, can be as high as eight or even 10 percent.
Let’s explore the difference between a home mortgaged at three percent compared to one mortgaged at eight percent. Assuming all other factors remain the same, we’ll do the math for a mortgage of $200,000 over 30 years at each interest rate to determine the total interest paid over the life of the loan.
|Three Percent||Eight Percent|
|Total Interest Paid||$103,480||$328,480|
As you can tell from the graph above, the interest rate savings from a prime mortgage with excellent credit compared with a sub-prime mortgage are staggering. Not only are the monthly savings enormous but the difference in how much you ultimately pay for your home is staggering.
Those savings alone are enough to make you think twice about purchasing a home with less than attractive credit. But there is much more to the story than that. It’s not just about your credit score.
While your credit score does greatly impact your interest rates when applying for a mortgage loan, they aren’t the only factors at play when it comes to determining what your loan interest rate will be. Even at these historically low interest rates, there are mitigating factors that can help you get more for your money when applying for a mortgage. This includes things like:
- Credit usage ratio. You typically want to be using less than 30 percent of the credit that is available to you which is why paying down your credit cards before applying for a mortgage is a good thing.
- Debt-to-income ratio. Lenders want to feel confident that you’ll be able to repay your debt before forking over $200,000 or more to help you purchase the home of your dreams. Your debt-to-income ratio assures them that you can handle your monthly mortgage obligations even with the other debts you have in your life.
- The term of your loan. Believe it or not, you can lower your interest rates beyond the dirt-cheap three percent threshold by taking out a mortgage loan for fewer than 30 years. That means if you take out a 10, 15, or even 20-year mortgage, you may end up with an even lower mortgage interest rate!
- Down payment amount. While you may be borrowing $200,000 to pay for your home, banks like to see you put a little “skin in the game.” Higher down payments, such as 20 percent or greater of the home’s total value, can earn you lower interest rates.
- Type of interest you’re paying. Typically, you have your choice of a fixed-rate mortgage or an adjustable-rate mortgage (ARM). Many home buyers are attracted by the lower interest rate offerings of an ARM. However, when you are already at or very near a historically low interest rate for mortgages, there’s only one direction for those rates to go. So when the next adjustment period arrives, it is likely that these rates that are so attractive today will be considerably less so when they are re-evaluated. Fixed-rate mortgages, on the other hand, are the same 30 years after you apply for your mortgage as they are the day you accept your mortgage.
Additionally, you may experience some difference in interest rates according to the loan type you are considering. For instance, government-subsidized or backed loans like the following may offer benefits that reduce interest rates for borrowers:
- VA loans.
- FHA loans.
- USDA loans.
Conventional loans will vary from one lender to the next so it may be worth your while to shop around to find the best possible mortgage rate if you do not qualify or prefer to avoid the government-backed loan programs listed above.
Now that you understand the basics about interest rates and mortgages, you can see that to maximize your advantage when it comes to a mortgage with historically low interest rates it is still essential to get your credit in order before applying for mortgages. While eight percent may be better for sub-prime mortgages than in decades past, three percent is the magic number you want to aim for when taking out a mortgage loan.
Getting More Bang for Your Investment Buck
While most people think of plunging interest rates as a good thing for spenders, few stop to view how it can benefit investors too. These are some investments to consider even when interest rates are low. Not only can they help you round out your portfolio, but they can also help you pad your nest egg quite a bit without huge concerns about potential losses along the way.
- Bonds. Historically, bonds have been used to bring stability to otherwise volatile stock or investment portfolios. Since bonds are a promise to pay X amount of dollars on specific dates and do not rely on interest rates at all, they are nearly ideal investments to consider until interest rates begin to rise again. The other benefit of bonds is that they can be used to provide a regular, dependable income once you reach retirement. The further out the bond matures (becomes payable to you) the higher the yield of said bond becomes.
- Real estate investments. Because interest rates are so low at the moment, real estate is becoming a far more attractive investment for many people looking for something with exceptional long-term growth potential in which to invest. From rental properties in college towns to vacation properties where you’d like to one day retire and even to potential Airbnb rental properties or commercial property rentals, the sky is the limit for real estate investing that maximizes the potential of these historically low interest rates.
Additionally, you may choose to play the odds with the understanding that while stock rates and interest rates have been through the wringer over the last year, they are likely to rise sometime shortly. They cannot hold forever at these low rates. When the rates once again begin to rise, you stand to enjoy wild profits thanks to the investments you’ve made today. Even buying underpriced stocks, though not without risks, can prove to be a winner for your portfolio once the world returns to normal and interest rates rise.
Mortgage Refinance Options and Potential Benefits
We’ve already discussed the value of historically low interest rates for mortgages. But many people fail to make the leap to mortgage refinance opportunities at lower interest rates. The key question, though, is whether it is in your best interest to refinance your mortgage for lower interest rates. The truth is that this is not an option for everyone. There are several key factors to consider before you decide to take the leap, including:
- Is your credit in better shape than when you received your original mortgage?
- Will the change in interest rate be one percent or greater?
- Do you anticipate moving in the next five years?
- Do you have adequate equity in your home? Do you intend to cash out the equity in your home?
- What are your goals in refinancing your mortgage loan?
Even though interest rates are at historic lows, choosing to refinance for all the wrong reasons might do you more harm than good. Especially if it jeopardizes your long-term financial health to do so. That doesn’t mean there aren’t many excellent reasons for refinancing your mortgage. What it does mean, is that you need to have a plan for what you intend to do with any money left over from the transaction to get maximum impact. This could include a variety of things, including:
- Paying off high-interest credit cards.
- Investing in the future.
- Paying toward your future mortgage payments or as a down payment.
These are all laudable goals, but what is your primary goal for refinancing your mortgage? Some of the common reasons people decide to refinance a mortgage include:
- Lower interest rates. Pay less for your home over time.
- Reduce monthly payments. Sometimes you need a little extra wiggle room in your budget. Refinancing at a lower interest rate can give you the wiggle room you require to get back on your feet.
- Lengthen the duration of the loan. In addition to lowering the interest rates, some people seek mortgage refinance as an opportunity to lengthen the duration of the loan. This in turn helps to lower the monthly costs even further. However, you ultimately end up paying more for your home making it decision that could prove problematic.
- Reduce the loan term. Another consideration is to lower your interest rate so you can pay the same amount each month for your mortgage while effectively reducing the term of your loan.
There are many reasons to consider refinancing your mortgage at these historically low interest rates. You will ultimately have to find your own reason for making this complex decision. Some of the times that are not good for refinancing your mortgage include when you plan to move within a few years or when you’ve suffered credit setbacks since your original mortgage. Otherwise, now may be the perfect time to consider a refinance mortgage if one has been on your mind.
While we are enjoying historically low interest rates today, that doesn’t mean they will last. Many believed they were going to increase just before the pandemic and many still believe that they will increase as soon as the economy begins to recover. Take advantage of the opportunity, now, to get more value from your dollar by taking out a mortgage, investing appropriately, or refinancing your mortgage.