Of the many decisions you have to make correctly when you are deciding on a home loan, timing the interest rate may be one of the biggest. Will interest rates increase, in which case you should lock in a fixed interest mortgage for as long as you can, or are they headed down, which means you want to either wait to buy or refinance, or choose a rate that adjusts frequently?
The interest rate on your home loan will be influenced by many factors and economic indicators, and having a basic understanding of these will help you in your choice. The first thing to understand is that interest rates are just the price of money and like all prices, they are influenced by supply and demand.
The first factor to examine regarding interest rates is the inflation rate. Inflation is measured by two important indicators called price indicators. They are the PPI and the CPI, the producer price index and the consumer price index.
PPI or Producer Price Index is a measure of the change in prices at the level of production. If PPI is rising, this will mean that the cost of finished goods is more, which will lead to inflation.
The Consumer Price Index (CPI) measures the change in prices of a given ?market basket? of consumer goods. It is considered the most important measure of inflation, since increasing prices that consumers pay for goods are the basis of inflation. Certain segments of CPI can ?skew? the results, so analysts frequently remove changes in food and oil prices, which can be too volatile. This allows them to look at the core inflation rate to better analyse where overall prices, and therefore inflation, are heading.
GDP is another fairly good predictor of inflation as well as interest rates. The Federal Reserve Bank tries to keep the economy growing at a sustainable rate; too slow and production will lag, causing a recession; too fast and the economy will overheat. The Fed therefore intervenes and when the economy is growing too quickly, it will raise interest rates to slow it down, or conversely, lower interest rates to stimulate the economy for increased growth.
An additional important indicator is the unemployment rate. Low unemployment is thought of as inflationary since employers have to chase after too few candidates, and will increase wages to do this. High unemployment usually leads to lower interest rates over time since employers can keep wages lower since there are so many candidates for each position. This is known as the wage price spiral; increased wages lead to increased prices, decreased wages to lower prices.
The prospective home purchaser can help himself by watching these indicators to attempt to determine rates. Normally, a slow economy with elevated unemployment will mean that rates will be falling. Conversely, higher GDP and decreasing unemployment will signal an increase in interest rates.
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