U.S. Treasuries have a global reputation as the safest investments in the world because they receive the full faith and backing of the United States government. Did you know that home mortgage lenders based the home loan rate you pay on these instruments? Long- term mortgages instruments, such as the 15 and 30-year fixed–rate mortgages have a direct correlation with 10-year and 30-year Treasury securities. This means when Treasury security rates rise, the interest rates follow.
Treasury rates decline, interest rates also go down. Home mortgage lenders peg adjustable rate mortgages (ARM) rates follow the yield on the 1-year Constant-Maturity Treasury (CMT) securities. Some lenders may use other indices, such as the Cost of Funds Index (COFI), and the London Interbank Offered Rate (LIBOR). The Treasury Department holds periodic auctions to sell Treasuries to investors. A low demand for Treasury securities means Uncle Sam will raise the yield, which consists of the interest the investment pay out, to make the instruments more attractive to potential investors.
How Interest Rates Affect the Economy
Historically, low interest rates have always fueled a healthy economy. The flow of “cheap” money to consumers not only helps make home mortgages affordable, but also encourages homeowners to refinance an existing mortgage. In addition, people may decide to make home improvements or buy new furniture and appliances for their homes. Also, consider the tradespersons, and hardware stores and other businesses that employ people, which provide them with the necessary income to purchase homes and other items in a thriving economy. Conversely, a rise in interest rate usually stifles the expansion and growth of the housing market as well as other sectors of the economy.
Often, the Federal Reserve may raise interest rates on Treasuries for slowing down the economy to prevent inflation. Since interest rates reached historical lows in October 2010, interest rates started creeping up from 4.2 percent to the current rate of around 4.8 percent. If you were to glance at a chart that plots both the yield on Treasury Notes and the 30-year and 15-year- interest rates, you would quickly notice mortgage interest rates moving in lock step with the yield on the Treasuries.
Should You Buy Before the Rate Goes Too High?
In a normal housing market, rising mortgage interest rates and an active economy usually motivate people considering buying a home to actually get off the fence and make a purchase before further increases. However, depressed housing prices, and the potential for home values to fall even lower in the near future, make the need to move now less urgent. From a historical perspective, even with the recent increases in the 30-year fixed- rate home mortgage, home prices remain affordable.
For now, tighter under writing criteria and higher down payment requirements present more of a challenge than higher interest rates. In addition, a weak job market and foreclosures continues to make many potential buyers wary of jumping into the market.
What to Do If You Have an Adjustable Rate Mortgage
Homeowners saddled with an adjustable rate mortgages should make sure they understand the terms and conditions of their home mortgage loans. During times of rising interest rates, payments can increase significantly over the life of the loan. The law states that all adjustable rate mortgages must have a lifetime cap. In addition, know what the “payment cap” is for your ARM. For example, if you have a payment cap of 5 ½ percent, your lender cannot increase your payment more that 5 ½ percent any one year regardless of how high interest rates increase. Below are a couple of options to consider if you have an ARM:
- You can prepay the loan by making an additional $50 or $100 each month. This lessens the amount you pay in interest on future principal.
- Many ARMs allow you to refinance the mortgage; however, be aware that some adjustable rate mortgages contain penalties or fees for selling your home or getting a mortgage refinance to a more favorable mortgage.
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