Commentary

Mortgage rates were up this week, not horribly and not enough to close down the current wave of financing and re-financing, but up nevertheless.

The major reason that mortgage rates go up and down relates to the matter of alternatives. If you have dollars you can put in the stock market, bonds, real estate, commodities, and other investment options. Your choice will be determined by such factors as risk, the rate of return, and the potential for appreciation.

In particular, when bonds become more popular, when more people want bonds, prices go up. When bond prices rise, yields go down. Yields for 10-year bonds relate somewhat to mortgage rates because mortgages are typically paid off within 10 years.

As an example, imagine that you can buy a $1,000 bond that pays 5 percent interest. A week from now the price of your bond rises 10 percent. The bond is now worth $1,100 if you sell.

Now let's look at the other side of the transaction. When the bond was bought for $1,000 the investor received $50 per year -- a 5 percent interest rate. If the value of the bond increases to $1,100 and the interest payout is the same, $50 per year, the yield then declines to 4.545 percent.

You can also work the system in the other direction. Imagine that the value of the bond fell to $900. It is still paying $50 percent. When the cost of the bond is $900 and the pay-out is $50, then the yield -- or interest rate -- rises to 5.555 percent.

So when bond prices rise, interest rates fall. And when bond prices fall, interest rates rise.

Notes

• Thirty-year, fixed-rate financing with 20 percent down, a conventional loan, consists of a mortgage with 360 monthly payments of equal size and an interest rate which remains constant throughout the life of the loan. At this time, conventional fixed-rate loans of up to $275,000 are available in the lower 48-states. In Hawaii, Alaska, Guam, and the U.S. Virgin Islands the loan limit for fixed-rate conventional financing is $412,500.

• Fifteen-year, fixed rate financing has a larger monthly payment than a 30-year loan, but lower interest rate and a smaller potential interest cost. Example: Suppose that the current interest rate for a 30-year fixed-rate conventional mortgage is 7 percent and the interest rate for a 15-year loan is 6.80 percent. For a $100,000 loan, the 30-year borrower would pay $665.30 per month for principal and interest. The total interest cost over 30 years (360 payments) would be $139,508. For the borrower who tales out a 15-year fixed-rate loan for $100,000, the monthly cost for principal and interest would be $887.68. Over 15 years (180 payments), the total potential interest cost would be $59,978.

• A jumbo loan is, essentially, a 30-year mortgage but with a loan amount above the conventional loan limit, in this case $275,000 for a single-family home in the lower 48 states. Because a larger loan amount is outstanding, lenders have more risk and so interest rates are somewhat higher than for conventional financing.

• An adjustable rate mortgage (ARM) is a form of financing which typically has an initial "start" rate lasting six months or a year, and then rates which change on a regular schedule. Because the interest rate changes, monthly payments can also rise or fall. The interest rate changes are based on an index not controlled by the lender such as the average price of Treasury bills over six months or a year, loans made by the Federal Home Loan Bank in San Francisco to lenders in California and Nevada (what's known generally as the11th District Cost of Funds Index), and the LIBOR rate (the London Interbank Offer Rate, a measure which relates to the cost of borrowing in Europe).

  Most ARMs have annual and lifetime interest caps, and also annual and lifetime monthly payment caps. Some ARM mortgages allow lenders to collect "negative amortization," an expression which means the interest cost is greater than the monthly payment, so the size of the debt increases.

• Interest rates are calculated at a given percentage of the loan amount per year, say 7 percent annually. A basis point is equal to 1/100th of 1 percent. Thus if a loan interest rate moves from 6.60 percent to 6.65 percent, it has gone up .05 percent or 5 basis points.

• Loans have a nominal interest rate, say 7 percent, and an annual percentage rate (APR). The APR is important because it includes not only the interest rate, but also such costs as points (loan discount fees), per diem interest, mortgage insurance and other expenses.

Be aware that the rates presented here may not reflect the rates for individual loan products at any given time, and that rates are constantly in flux. For additional information regarding current mortgage rates, please consult the Bank Rate Monitor

Published: June 4, 2001

Use of this article without permission is a violation of federal copyright laws.