What Makes Interest Rates Fluctuate?

by | Jan 5, 2022 | Interest Rates | 0 comments

If you are planning to take out a home loan, you might benefit from learning about the interest rates on your mortgage. It will be especially helpful if you plan to take out a variable rate mortgage, in which your interest rate can rise and fall with changes in the market. You need to have a general understanding of why interest rates fluctuate to make better-informed decisions about lending money for your new home. 

That said, multiple interlinked factors cause mortgage interest rates to fluctuate, including a change in the supply and demand of loans, government policies, and the global economy. These factors can cause lenders to hike or decrease the interest they charge on your mortgage. 

 

Why Do Interest Rates Fluctuate – 6 Factors Affecting Interest Rates

Here are some of the most common factors that affect mortgage interest rates: 

  • Supply and Demand

If there is an increase in the demand for credit or loans, the interest rates will hike. On the flip side, if there’s a dip in demand, the rate will decrease as well. Conversely, the increase in credit supply will reduce interest rates, while a reduction in credit supply will increase the rates. 

The increase in supply is because of the increase in the amount banks make available to the borrower and vice versa. For instance, if you open a bank account, you effectively lend money to the bank. The bank can use this money for its business and investment ventures, i.e., lend money to other customers. The more money banks can lend, the more credit available to the economy. The supply of credit increment will decrease the borrowing price, i.e., the interest. 

The credit available to the economy will decrease if borrowers start deferring the loan payments. For instance, when you don’t pay your monthly credit card bill on time and delay it by a month, you increase the amount of interest you will have to pay and decrease the amount of credit available in the market, increasing the interest rates in the economy.  

  • Inflation

Inflation is a significant factor that can and does affect mortgage interest rates. Typically, home loans are grouped into larger securities, so the market for these investments affects the interest rates on mortgages. Investors aim to preserve their purchasing power. So, if the inflation is high and risks are higher, they demand a higher interest rate for lending their money. 

It all ties back to the relative value of the dollar. As inflation occurs, it’s fairly common for interest rates on all sorts of loans to increase as a means of protecting the dollar value. Investors demand a higher rate as compensation for the decrease in the purchasing power of the money they are paid in the future. 

  • Economic Growth

Changes in the economy will also affect mortgage interest rates. If the economy is doing well, people will have greater personal wealth reserves, which will also drive spending. As a result, lenders will lower the interest rates to encourage more spending in the housing market. On the flip side, if the economy is not doing well, lenders will increase the interest rates to offset the risk they might face in payment delays. 

  • Government Sanctions

Government sanctions can also cause interest rates to fluctuate. The US Federal Reserve often announces how its monetary policy will affect interest rates. The federal fund rate is the rate institutions charge each other for exceptionally short-term loans. It affects the interest rate banks set on the amount they lend to borrowers, including short-term lending rates. 

The Federal Reserve influences these rates with “open market transactions,” which effectively entails the selling or buying previously issued US securities. When the government purchases more securities, banks are flushed with more money than they can use for lending, which results in a decrease in the interest rates. On the flip side, when the government sells more securities, it drains the money from banks, resulting in fewer funds for lending, which results in a higher interest rate.  

  • Multiple Global Factors 

Unemployment, political unrest, foreign competition, and other global factors can also affect mortgage interest rates. When the global economy is unpredictable or suffering, it can cause the Federal Reserve to hike the rates to anticipate inflation. It’s why you will notice that interest rates will always increase when there’s a global conflict or any global economic instability. 

  • Types of Loans

Another huge factor that explains why interest rates fluctuate is the type of loan you want to borrow. The interest rate for each type of loan is determined by the time, credit risk, tax consideration, and loan convertibility. 

Risk essentially entails the likelihood or lack thereof of the loan being repaid timely. If there’s a greater chance of the loan not being repaid, the lender will charge a higher interest rate. However, if the loan is secured, i.e., the lender has some collateral they will receive if the loan is not paid back, they will charge a lower interest rate since the collateral will offset the risk factor.

The time of loan repayment is also a huge factor. Long-term loans contain a higher risk of deferment and can be affected by inflation, which is why they also have a higher interest rate. Lastly, loans that you can convert into money quickly without suffering any loss will carry relatively lower interest rates. 

 

The Bottom Line

If you plan on buying a house, make sure to consider the factors above that might affect the interest rate on your mortgage. Ultimately, if you wish to secure a low rate, you need to understand the market, the supply and demand conditions, inflation, and other global economic factors. You will also need to assess your financial position and your ability to repay the loan to determine the interest rate you will receive from a lender. 

If you’re looking for reasonable mortgage interest rates for buying your new home, get in touch with Integrity Mortgage today!

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