If you've read a newspaper or watched the news in the last few weeks, you've probably seen something about mortgage rates and the Federal Reserve banking system. Like many borrowers, you might be curious about how the Fed sets interest rates and how a rate hike could affect your personal finances. Here are the main points:
Fed banks lend money to banks, credit unions, and other places that lend money. Since these institutions only need the money for a short time, they pay a discount rate that is set by the Federal Reserve Board. This discount rate has a direct effect on the "Prime Interest Rate," which is the rate that banks charge their best commercial customers for short-term loans.
The Fed's board of directors meets once a month to set financial policy, change interest rates, and make predictions about the economy. Since June 2006, the Fed has raised interest rates several times. This was done to keep the economy stable, but it could make it harder for your family to get money. If you have a mortgage, a home equity loan, and any amount of credit card debt or personal loans, now is probably a good time to look at the damage and, if necessary, refinance your current mortgage.
Mortgages with a fixed rate
A 30-year fixed-rate mortgage may not be the most innovative choice, but it is often the best one. Even if the Fed decides to raise the discount rate, the first rate on an adjustable-rate mortgage will likely be lower, but the payments on a fixed-rate mortgage won't change. Fixed-rate mortgages make sense for people who want stability and don't plan to move in the next 5–7 years.
Adjustable-rate Mortgages
The main benefit of an adjustable-rate mortgage, or ARM, is that the initial interest rate may be lower than that of a fixed-rate mortgage. But because your rate is variable, you will probably see higher rates and bigger monthly payments at some point in the future. Some ARMs change every month, but most change every 6 to 12 months based on economic factors like the federal interest rate and a financial formula.
Hybrid ARM
Many borrowers choose the hybrid ARM, which usually has a low fixed rate for a certain amount of time (1/1, 5/1, and 7/1 are common hybrids) and then adjusts every year. These changes are made every year and are based on federal rates. If you only plan to live in your home for a few years, a hybrid ARM with low introductory rates might be a good choice, but be aware that the rates will change in the future.
