While the credit crunch is clearly dampening consumers' borrowing power, the lending well hasn't run completely dry. Lenders still want to lend, but borrowers will need to dig deeper to get the best rates.
The Federal Reserve probably plays the most visible role in influencing rates, as it orchestrates money supply. Contrary to popular belief though, when the Fed trims rates, the effects don't necessarily trickle down to every credit and loan product.
Between September 2007 and April 2008, the Fed cut the federal funds rate 3.25 percentage points, from 5.25 percent to 2 percent. Yet over that time frame, the average 30-year fixed-rate mortgage actually rose, according to Bankrate data.
Rates on other loan products did fall, including those for home equity lines of credit, or HELOCs, auto loans and variable rate credit cards. Their rates are pegged to the prime rate, which moves in tandem with the federal funds rate.
Knowing what influences interest rates may help you negotiate a better deal the next time you need to borrow money.
The skinny on ...
- Home equity
- Credit cards
- Auto loans
- Student loans
- Personal loans
1. The skinny on mortgage ratesWhat impacts rates: Fixed-rate mortgages are influenced by the current economy and investor expectations.
"Fixed-rate mortgages are pegged to long-term interest rates, like the 10-year Treasury note and are not connected to short-term interest rates controlled by the Fed," says Greg McBride, Bankrate's senior financial analyst.
Short-term rates do affect adjustable-rate mortgages, or ARMs, because the indexes to which they are pegged are shorter term in nature, says McBride.
"Adjustable rate mortgages are often pegged to the one-year Treasury or a short-term LIBOR index, either of which is more closely correlated with the short-term interest rates under the Fed's control," he says.
Risk-averse lenders reeling from record losses from the subprime mess are impacting mortgage rates, too. Lenders are requiring tougher underwriting standards on new mortgages.
Investors who buy mortgage-backed securities are demanding higher yields to compensate them for taking higher risks.
These factors have prevented mortgage rates from falling lower than they are today.
It's tough to lend money for homes while housing values remain uncertain, says Bob Walters, chief economist at Livonia, Mich.-based Quicken Loans.
"If you're lending against something that you think continues to lose value, how do you make your (lending) rule when you make a loan in May and by July you're upside down on that loan?" he says.
Highs and lows: Over the past five years, 30-year fixed-rate mortgages have ranged from a low of 5.28 percent in June 2003 to a high of 6.93 percent in June 2006. In recent weeks, rates have been approaching those 2006 levels.
Fifteen-year fixed-rate mortgages over the past five years ranged from a low of 4.71 percent in June 2003 to a high of 6.57 percent in June 2006.
And 5/1 ARMS, for which Bankrate has data for two years, ranged from a low of 4.99 percent in February 2005 to a high of 6.67 percent in June 2007.
For information on the latest mortgage rates, see Bankrate's mortgage survey.
How to get the best rate: Until the mortgage crises fully ebbs, lenders will likely continue to tighten their mortgage lending standards.
You'll need proof of stable income, preferably a tenure of two or more years at the same employer, a FICO score of at least 720 score and a verifiable down payment -- plus cash reserves, says Ritch Workman, president of the Florida Association of Mortgage Brokers.
"That's our poster-child borrower," he says. "They're the ones being offered the best rates."
With zero-down-payment loans going the way of the horse and buggy, expect to cough up more money at closing to qualify for the best rates -- especially if you're near the conforming loan limit for your area. (Conforming loan limits vary according to area, but are predominately $417,000. A conforming mortgage is one that is eligible for purchase or securitization by government-sponsored enterprises such as Fannie Mae and Freddie Mac.)
"It pays to strategize to either make a larger down payment or borrow less money so you can get that mortgage under that conforming loan limit and at a lower rate," McBride says.
Another rate-reducing strategy is to pay discount points or an origination fee upfront. Both fees are expressed as a percentage of the loan amount, and both will decrease the interest rate of a mortgage, but will increase the amount of cash you need at closing.
On a $200,000 loan, a 1 percent origination fee (also called loan-processing fee) will mean $2,000 out-of-pocket at closing.
Origination fees may or may not be negotiable. Some lenders won't write a loan without an origination fee, says Workman.
How much do discount points lower your mortgage rate? It depends on what's going on in the mortgage market, but one point usually lowers the interest rate by one-eighth to three-eighths of a percentage point. General rule of thumb: One discount point equals a quarter-point rate reduction.
Paying points generally means reduced monthly payments and interest over the life of the loan, but you'll need to consider how long you plan to stay in the home to see if the trade-off is worthwhile.
"If it takes more than 24 to 36 months to pay off the point, it's typically not worth it financially because most Americans sell or refinance their home within five years," Workman says.