What Is Interest Rate Volatility? Your Guide

interest rate volatility

interest rate volatility

If you’re looking to purchase your first home, you’re probably looking to do so with the assistance of financing, like most first-time homeowners today. And obviously, you’re looking for the best possible mortgage terms to suit your budget. One of the most important factors to consider when settling on a mortgage option is the mortgage interest rate you’re offered. Why? Because it has a significant impact on the overall, long-term cost of purchasing a home. This is where interest rate volatility plays a large part in how mortgage lenders manage their risk, and the overall cost you pay.

But what exactly is interest rate volatility anyway? This blog everything you need to know.

Interest Rate Volatility: How Does It Work?

In order to understand why you’re offered a certain interest rate on your mortgage, it’s important to get to grips with all the factors that actually affect the mortgage rate universe. One of the most important being interest rate volatility.

In basic terms, interest rate volatility refers to the frequency at which interest rates on loans (such as mortgages) vary and fluctuate over time. Businesses, investors, and homeowners alike are all impacted by interest volatility rate.

For example, a business owner must track and recognize interest rate fluctuations in order to capitalize on savings rates and borrowing rates. The same goes for investors.

No matter how good your credit rating is or how good you are at managing your finances, there are economic factors that are out of your control. Not-to-mention government monetary policy that affects interest rate volatility, too. All of which impacts the mortgage interest rate you’re offered.

What Are the Different Types of Interest Rates?

Globally, there are two main types of interest rate indexes that dictate how the market fluctuates. They are the fed funds interest rate and the LIBOR interest rate.

The U.S. Federal Reserve Bank has a major influence on interest rates across America, as set by the Federal Reserve’s Open Market Committee. While the London Interbank Offered Rate (LIBOR) influences the interbank market within the United Kingdom. As well as nations including Switzerland, Canada, and the United States.

Interest Rate Fluctuations

The timing of interest rate fluctuations is dictated by the Federal Open Market Committee and LIBOR. The fed funds rate fluctuates based on changes that the committee views as necessary to influence monetary policy.

To add to this, when the Federal Reserve aims to increase the circulation of money, it will reduce interest rates. When the Federal Reserve identifies a need to curb money circulation, they increase interest rates.

All in all, this means they have a direct impact on the state of the economy and can choose when to stimulate it or not.

The LIBOR interest rate changes on a daily basis. They publish new interest rate indexes every day at 11:45, am (UK time). The British Bankers Association calculates interest rates on a daily basis by gathering overnight rates and full-year loan rates.

They pull this information from London’s top 16 banks within the interbank market. After that, they determine the new interest rate for the following day.

The Significance of Fed Funds vs. LIBOR

The fed funds rate largely relates to the U.S. interest rate. It is the underlying index for interest rates set by mortgage lenders and credit card issuers. It’s also a long-term indicator of U.S. interest rate volatility. It’s usually a reliable indicator for 12 months or more.

The fed fund also influences interest rate indexes between U.S. banks, and how they lend money to each other. It’s also responsible for affecting the prime rate of the Wall Street Journal and many other consumer products. Some of which include credit card rates, lines of credit, auto loans, personal, loans, and small business loans.

LIBOR, on the other hand, is a short-term interest rate indicator due to how it changes on a daily basis. It reflects what is taking place in the overall interest rate universe.

In other words, if the LIBOR interest rate increases, banks will view the lending market as higher risk. On the other hand, if the LIBOR interest rate decreases, this is a sign that the lending environment is less risky. Interest rates, in general, will most likely decrease as a result.

Factors That Impact the Interest Rate Volatility Index

There are numerous factors that impact interest rate volatility and the mortgage rate you’re offered by a lender. As mentioned, many of them are out of our control.

Remember that the U.S Federal Reserve plays a huge role in setting monetary policy. This directly impacts interest rates and whether they are high or low.

The stability of the economy, borrowing and lending rates, consumer market uncertainty, global disaster, etc. all have a direct impact on interest rate volatility, too. However, when it comes to purchasing your first home, these are the most important factors to consider:

1. Inflation

Inflation is a direct reflection of the overall health of the economy. Prices will gradually increase if the state of the economy as a whole is struggling. You can think of inflation as a power that erodes the value of money.

This has a direct impact on mortgage lenders, the risks they can take, and the interest rates they offer. When inflation is high, they have to maintain their interest rates at a level that will overcome the eroding power of inflation.

2. Economic Growth

The rate of economic growth within a country has a direct impact on interest rate volatility. Growth indicators include things like the employment rate and a country’s GDP (gross domestic product). Ultimately, these factors have a direct impact on mortgage interest rates.

When economic growth is high, this increases consumer spending, better employment rates, and wages. As a result, the demand for mortgages increases, and so mortgage rates increase too. This is because mortgage lenders are limited by the capital they have. They have to increase mortgage rates to make up for any shortfall.

3. Monetary Policy

As outlined earlier, the Federal Reserve Bank has significant influence over the state of the economy and resulting interest rate volatility. Depending on the type of monetary policy they issue, this has a direct impact on mortgage interest rates.

While they do not set specific interest rates for the housing market, the fed funds interest rate determines whether money is in supply or not. If policy promotes an increase in money circulation, interest rates decrease. If money circulation decreases, interest rates rise.

Find the Best Mortgage Option to Suit You

Interest rate volatility has a direct impact on the overall cost of the mortgage you pay. While there is no way to control market volatility, you can control the type of mortgage you choose and the lender that helps you find the perfect fit.

If you’re looking to become a first-time homeowner, allow the Lindley Team to guide you in the right direction. We offer three decade’s worth of insight into the mortgage lending process. Learn more about our lending options, here.

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