Why Do New Loans Have High Interest Rates?
Mortgage rates on new loans are hovering around 7% right now. A far cry from the 3% loans people were getting just a year ago!
I’m sure you’ve heard of this before… but do you understand why it is happening?
Here is why mortgage interest rates on homes being purchased now are over double what they were a year ago and real examples of how many more dollars in interest it can lead to you paying:
- We put a lot of stimuli into the economy and the economy recovered from COVID exceptionally fast! Good news for 2020 us.
- Uh oh… it recovered too fast. Supply chain issues, low unemployment, and increased spending has led to inflation. You now have to pay way more for a cart of groceries or a new house than you used to.
- In comes the Fed trying to save the U.S. from inflation doom. It is quite literally one of their only jobs to control inflation, after all. However, it is my opinion that they didn’t swoop in and battle rising inflation as fast as they should have. They thought their new enemy would just “go away” on its own, because it was “transitory.” Then suddenly – WHAM – inflation firmly planted itself into the economy as a formidable foe. To save us all from inflation, they increased Federal Funds interest rates much faster than they originally planned.
- All loans are based on the Fed Funds rate. Banks generally add 3% to the Fed Funds rate to determine the prime rate they will offer to their most trusted borrowers. So, if the Fed Funds rate goes up .50%, so does the prime lending rate to consumers. So, next thing you know, the Fed Funds rate is 4.5% making the prime rate 7.5%.
So, how exactly does the Fed increasing interest rates help fix our skyrocketing costs? Because they are slooooowwwwing down the economy. If people are living free and filling their garages with cars financed at a 2% rate, the price of those in-demand cars is going to be insane and become completely unaffordable. So, if the Fed can increase the Fed Funds rate and encourage higher loan rates, fewer people will be buying cars… Theoretically, then, the price of the cars will have to come down because of lower demand.
This applies on a micro scale when it comes to individuals buying cars, homes, and home goods, but it also applies to major investments from businesses. They are likely to slow down expansions, because borrowing the money to do so is too expensive. That might mean they will also slow down hiring.
The Fed is slapping their wet mop on our once happy economy because it started to burn too bright. Unemployment has been too low, wages were increasing too fast, consumers were buying too much…. What sounds like a dream was actually a recipe for inflation disaster.
So, that is why that $300,000 house you want now has a 7% mortgage rate rather than a 3% mortgage rate. Also meaning… You are going to pay $260,000 more in interest over the life of your loan. I’m not going to tell you if you should take that new higher loan or not. But – I hope you at least now understand the dynamics of WHY you are owing more.