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How To Understand How Interest Rates Behave
If you are considering buying a home or refinancing your present one, you probably are asking yourself if this is the right time. Those who think rates will increase want to buy now and take advantage of currently lower rates, and those who think they will go down want to wait until a better time.
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 make your choice. The first thing to realize is that interest rates are actually the price of money and like all prices, they are determined by supply and demand.
Inflation is one of the very important factors in interest rates. The inflation rate has two primary indicators. These are the producer price index as well as the consumer price index.
PPI is the fluctuation in prices at the stage where goods are produced. Increases in the Producer Price Index means higher prices for finished goods, and that translates to inflation.
CPI, or Consumer Price Index is the change in prices at the consumer level, as determined by a standard basket of goods. This is a very important signal of inflation since this is what we will all pay for our goods. The basket of goods used is indicative of the types of goods consumers usually buy, and because it includes food and energy prices, which can move up and down too much, they are frequently removed from of the equation. The remaining items form the core inflation rate, which will indicate to us how prices will perform in the future.
GDP is the next widely used indicator of how inflation and in turn interest rates will behave. Central banks try to foster slow, steady growth in the economy, since no growth means recession, and too fast growth means inflation. The Fed has certain tools to control interest rates and will use them to increase rates when it needs to slow the economy down and decrease them when it needs to help the economy to pick up.
The unemployment rate is another major component of the economy that affects interest rates. If the economy has low unemployment, inflation will most likely follow since salaries have to go up to attract candidates. If the economy has high unemployment, interest rates will fall because salaries will fall because employers do not feel compelled to offer higher salaries to retain workers. Lower wages mean lower prices which means lower inflation.
Keeping track of these interest rate indicators will help you to choose when it is a good time to enter the home loan market. The bigger picture to watch out for is a lower GDP with unemployment which will predict lower rates. On the other hand, higher GDP and decreasing unemployment will signal an increase in interest rates.
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