Probably the most misunderstood concept in mortgages is the interest rate. And yet, probably nothing plays a bigger role in our entire financial system.
The term “Interest Rate” itself is broad in that it can refer to anything from the Fed Funds rate, which drives the short term Adjustable Rate Mortgages and is directly controlled by the Federal Reserve, to any of the Treasury Note yields that drive the longer-term 15 and 30 year fixed rate mortgages.
There are also classifications of Intererst Rates: Simple interest and Compounded Interest: Simple Interest is simply the product of the principal, the interest rate (per period) and the number of time periods.
Compound interest: Compound Interest is much similar to Simple Interest; the principal changes with every time period unlike simple interest where the principal is the same.
In today's market, many people have found that refinancing into a slightly higher interest rate can improve their financial position. This is done by eliminating credit card debt or other consumer debts with a new mortgage loan.
All money borrowed has an interest rate that is charged to the borrower, the interest rate is how the lending institution makes its money. The lower the risk of default the lower the interest rate generally is. You will pay less interest with a 720 credit score then someone with a 450 credit score.
For adjustable rate mortgages there are many different rate indexes that can be used. Two of the more common indexes are known as the "Prime Rate Index" and "LIBOR". The Prime rate index is the most common as this is what is commonly affected and what everyone hears about when they hear of the Fed increasing or decreasing interest rates. LIBOR stands for the London InterBank Offered Rate and is another very common index used with adjustable rate mortgages. The way an adjustable rate mortgage works is that the rate consists of 2 components, the index and the margin. Your actual rate is calculated by adding the margin and the index together. The margin is a fixed amount that is added to the index. The index is the variable part of an adjustable rate and goes up and down with the market. Therefore, if you are considering an adjustable rate mortgage it is important for you to understand how your rate is created and what index you are using for your loan.