How mortgage lenders come up with interest rates and pricing is a mystery to most homebuyers and homeowners. But many of the factors that affect mortgage rates are things over which lenders have no control — for example, oil prices. Here’s how oil prices affect your mortgage rate, and what to do about it.
What causes oil prices to change?
Oil prices increase when demand for the resource goes up, or when its supply goes down. That’s because more buyers are competing for less oil, and sellers can raise their prices. Threats of instability in oil-producing regions, agreements to cut oil production, increases in manufacturing activity and escalation of wealth in developing countries (more cars) can all cause oil prices to rise.
The opposite is also true. Economic cooling can cause demand for oil to fall off, and discovering new sources can unleash the supply — causing prices to fall.
How do rising oil prices affect interest rates?
Rising oil prices tend to take the cost of producing and shipping many of our goods with them. So an increase in oil prices may be felt across the board by everyone, not just people who drive Hummers. That’s inflation. And when prices are rising faster, investors require a greater rate of return — the interest that they charge borrowers.
For instance, if prices are increasing at a rate of 2 percent per year, investors may be happy to lend the government money by purchasing Treasury Notes paying 4 percent. But if inflation rises to 4 percent, they will want a higher interest rate to keep from losing money — say, 6 percent.
This is the case with all forms of borrowing — from the rate the Federal Reserve charges banks, to the Prime Rate lenders charge their best customers, to mortgages, credit cards, auto loans and student borrowing. Every lender will want more interest to compensate for the higher prices they expect to pay in the future.
In short, the expectation of higher prices in the future can trigger interest rate increases right now.
How oil prices affect your mortgage rate
When increasing oil prices cause costs for everything else to go up, they trigger inflation — the expectation that prices for the same items in the future will be higher than they are today.
And when investors expect inflation, they demand higher rates of return before they will loan or invest their money. So for lenders to get money to fund mortgages, they have to pay more. And they have to charge you more.
What to do about higher oil prices and mortgage rates
When you’re considering buying or refinancing a home, pay attention to the economy. Pay attention to oil prices, because they change constantly. When you see them fall, check to see if mortgage rates have dropped, and consider locking in your interest rate.
When rising oil prices are causing sustained interest rate increases (this is called a rising rate environment), you may just want to lock in your loan and protect yourself from possibly higher mortgage rates — especially if a higher rate would make your home loan unaffordable.
It’s smart to pay attention to the economy when you’re in the market for a mortgage, but don’t drive yourself crazy over things you can’t control, like oil prices. Much of the time, mortgage rates change by just fractions in a given day — often less than 1/8th of 1 percent.
However, the difference between what different mortgage lenders charge on a given day is much higher — generally between .25 and .5 percent for a 30-year fixed loan. You accomplish a lot more by shopping among competing mortgage lenders for the best rates available than worrying about fluctuations in oil prices.