Mortgage Interest Rates Trends and the Housing Market

Ngaji, Terngu

Loyola Marymount University Los Angeles, California

December 3, 2013

Summary This paper unveils the effects of frequent changes of mortgage interest rates in the housing market on October, 2013. It tries to explain if the anticipation of increasing interest rates increase home purchases or otherwise. According to the articles used for this research the benefactors of the changing mortgage interest rates in the market are the homebuyers (in terms of when the fraction of principal or loan repayments become greater than the fraction of interest payments), the home sellers (in terms of the time the investors will get returns on their investments), and the loan issuing financial institutions (in terms of when the institutions will get their returns for issuing out loans). Furthermore, the paper delves on the effects of the partial government shutdown on the housing market in terms of homebuyers behavior and mortgage interest rates. The interest rates on mortgage loans were relatively low. The average interest was 4.28% in the third week of October, 2013.1 This slight increase in mortgage interest rate began to spur the housing market as homebuyers were rushing to purchase houses before the interest rates will go up.2 However, the government partial shutdown decreased consumers confidence because of the uncertainty of the interest rate on mortgage loans. Since mortgage rates tend to be positively correlated with the economy, if banks and mortgage lenders think the economy is slowing they will lower interests rates to attract more business.3 Analysts assume that banks and

According to Wall Street Journal (2013), the interest rate was 4.28 as of October 17, 2013; this rate was up from 4.23% the previous week, and 3.37% a week earlier. For details visit this link: http://online.wsj.com/article/BT-CO20131017-707225.html?mod=wsj_share_email. 2 In this paper, nominal interest rate is referred to as interest rate. 3 Forbes (2013), offered four reasons why mortgages rates will likely plummet because of the recent government shutdown. For details visit this link: http://www.forbes.com/sites/realtorcom/2013/10/04/4-ways-governmentshutdown-effects-new-mortgages/.

lending institutions will likely maintain the low interest rates in order to build consumer confidence. In summary, under normal conditions, if other factors are held constant, consumers will rush to buy homes when interest rates are low so that their fraction of loan repayment (that is repayment of principal) will be higher than interest payments in the earlier years as opposed to otherwise where the fraction of the interest payments on the loans will be higher than the repayment on the principal in the earlier years. Home sellers (or developers) will be motivated to invest in or build new houses if they think they will get adequate returns on their investment with the current interest rates if the interests are low the investors see the increasing volume of demand for houses as a chance to increase sales and profits. Because interest rates are largely determined by macroeconomic forces events such as government shutdown can increase risk for investors in the housing market. Analysis The incentive for many homebuyers, investors, and lending institutions in making certain financial decisions is likely due to the expected rewards associated with it. After the 2008 financial meltdown many people in United States were sensitive in terms of spending on both consumer and capital goods. The housing market had enormous impact due to consumers sensitivity on interest on mortgages offered in the housing market after 2008. Many consumers now favor the view of buying homes on terms that will allow them to start paying off their loans with the principal constituting the larger fraction in the early years of the mortgage terms. This follows that, homebuyers in todays economy are much more motivated to obtain mortgages with lower interest rate.

According to the Wall Street Journal (2013) and the LA Times (2013), Freddie Macs survey on October 17, 2013, showed that lenders offered 30-year home loan at an average of 4.28%; this rate was up from 4.23% the previous week, and 3.37% a week earlier.4 That means if a homebuyer obtains a mortgage at 4.28% the interest payments on the mortgage loan will exceed the actual principal repayment for the first 14 years and 10 months. The actual principal repayment will exceed the interest payment on the 11th month of the 14th year (period 167).5 At this point the repayment of the principal will be $618.63 and the interest payment on the mortgage will be $615.61. That means the ratio of the principal repayment to interest will be approximately 1.005. Had there been the homebuyer obtained the mortgage the week the interest rate was 4.23%, the repayment on principal would have exceeded the interest payment in the same 14th year but in the 9th month (September instead on November) on period 165. Furthermore, if homebuyers obtained mortgages in the first week of October, 2013, when the rate was at 3.37% the repayment of principal ($549.10) would have exceeded interest payment ($547.17) in February of the 10th year (period 110). The difference of the 30-year mortgage terms within October, 2013, is noticeable and interesting. For the 15-year term mortgages supplied to the market, as of October 17, 2013, the rate was 3.33%, compared with 3.31 the previous week, and 2.66% the week earlier.6 For the 15-year term mortgages, the repayments of principal exceed the interest payments from the first month (period 1) to the last month (period 180). The difference lies in the amounts of interest paid and principal repayments. For instance, in the first month mortgages with rates
4

For more details about the Wall Street Journal report refer to the link in the first footnote on page 2. For more detail about the report of LA Times refer to this link: http://www.latimes.com/business/money/la-fi-mo-freddie-macmortgage-rates-20131017%2c0%2c358695.story#axzz2lbw8AvWN. 5 Refer to the amortization schedule of the 4.28% 30-year mortgage for details. 6 This report was provided by Wall Street Journal. For details refer to the link provided in footnote 1 on page 2.

3.33% paid $693.75 for interest and $1,072.66 for principal; 3.31% paid 689.58 for interest and $1,074.39 for principal, and; 2.66% paid $554.17 for interest and $1,131.70 for principal. The differences in the interest and principal payments are financially significant. Notice that the 15-year term mortgage loans tend to have lower interest rates than the 30-year term mortgage loans. This is because the lending financial institutions, individual investors (lenders) and financial analysts feel that loans with longer terms are riskier than loans with shorter terms. Lower interest rates are typically provided for short-term loans to motivate consumers to obtain them because of the earlier principal repayment incentive. Can external or macro-economic factors affect interest rates? Yes. Marco-economic factors such as the recent government shutdown in United States can affect interest rates immensely. If the government shuts down and default on its loans interest rates will automatically shoot up if careful measures are not taken and this will affect not only mortgage interest rates but interest rates on Auto financing, credit cards, and even student loans. This will affect suppliers in the market because their sales will decrease. As long as interest rates on loans are low, consumers confidence tend to increase gradually. Therefore, formulating and implementing economic and financial policies that provide auspicious interest rates in the market tend to increase demand (in this case increase demand houses in the housing market).

Bibliography
Forbes. (2013, October 4). 4 Ways Government Shutdown Affects New Mortgages. Retrieved from Forbes: http://www.forbes.com/sites/realtorcom/2013/10/04/4-waysgovernment-shutdown-effects-new-mortgages/ LA Times. (2013, October 17). Freddie Mac: Mortgage Rates Higher Amid Crisis; 30-Year at 4.28%. Retrieved from LA Times: http://www.latimes.com/business/money/la-fimo-freddie-mac-mortgage-rates-20131017%2c0%2c358695.story#axzz2lbw8AvWN Wall Street Journal. (2013, October 17). U.S. Mortgage Rates Mostly Higher in Latest Week Freddie Mac. Retrieved from Wall Street Journal: http://online.wsj.com/article/BTCO-20131017-707225.html?mod=wsj_share_email

Internet Links:
Forbes: http://www.forbes.com/sites/realtorcom/2013/10/04/4-ways-government-shutdowneffects-new-mortgages/ LA Times: http://www.latimes.com/business/money/la-fi-mo-freddie-mac-mortgage-rates20131017%2c0%2c358695.story#axzz2lbw8AvWN Wall Street Journal: http://online.wsj.com/article/BT-CO-20131017707225.html?mod=wsj_share_email