Credit Shocker: See What Today's Low Interest Rates Really Mean for Mortgages

Interest rates have been near historic lows for many years now, but they have been inching up, and it seems likely that the Federal Reserve will keep hiking them for a while. Interest rates are very influential in our financial lives, so it's smart to keep an eye on them.

In particular, interest rates influence how much house we can afford to buy. If you think you've missed the boat in getting a great mortgage deal because rates are on the rise, think again. There's still time to snag a low rate.

Image source: Getty Images.

Interest rate history

We've been stuck in an environment of ultra-low interest rates for so long that it can be hard to remember how high they have been and can get in the future. Below is a review of some past "prime" rates -- the prime rate, influenced by the Federal Funds Rate, is the lowest rate at which money can be borrowed commercially.

Source: Fedprimerate.com. 

Clearly, interest rates have varied widely in American financial history. Now let's take a look at what they mean for home buyers and mortgages.

Image source: Getty Images.

The Fed Funds Rate and mortgage interest rates

Many people assume that when the Federal Reserve sets interest rates, it's also setting mortgage interest rates. That's not quite true, though. Mortgage rates and many other rates are often tied to or at least influenced by the Fed's actions, but the Fed doesn't set them. Indeed, on occasion they've moved in the opposite direction of Fed actions.

The Fed does set a target range for the Fed Funds Rate, though, and following the credit crisis of 2008 and 2009, that range was repeatedly cut, hitting a low of between 0% and 0.25% in December 2008. It stayed there for seven years, until the target range was raised to between 0.25% and 0.5% in late 2015 and to between 0.5% and 0.75% in late 2016. There were three increases in 2017, bringing the range to between 1.25% and 1.5%. The Fed left rates unchanged at its Jan. 31, 2018 meeting, and the next decision will be made on March 21.

Mortgage rates: How much house can you afford to buy?

Mortgage interest rates determine how much you'll be paying each month for the privilege of borrowing money from a lender in order to buy a home. High rates can either send your monthly mortgage payments through the roof -- or, if you keep your payment size in check, they can restrict how much home you can afford to buy.

Below is a look at average interest rates for 30-year fixed-rate mortgages in past years, along with the kind of monthly payment they would require if you were buying a $250,000 home and paying 20%, or $50,000, down. The last column shows the total amount of interest you'd pay over the life of the loan. (If the kind of home you'd likely buy is more in the $500,000 range, just double the numbers.)

Sources: Freddiemac.com, Bankrate.com calculator. 

The table above is fascinating and alarming, no? Look at what a hugely different situation you'd be in if you wanted to buy a home in 1982 instead of 2018. Today your monthly mortgage payment might be less than $1,000, with total interest paid over 30 years below $150,000. In 1982, you'd be paying nearly $3,000 per month -- more than three times the 2018 rate! -- and you'd be forking over more than $850,000 to your lender. Notice that the 2018 homebuyer pays 58% of the value of the home he's buying in total interest, while the 1982 homebuyer pays more than three times the value of the home.

The situation doesn't have to be quite this dire, though. If interest rates soared into double digits soon and you wanted to buy a home, you might opt for an adjustable-rate mortgage (ARM), which will ratchet down your monthly payments if and when interest rates fall, as they would eventually be likely to do. You might also buy a less expensive home in order to shrink your monthly payments.

When steep interest rates are good

Sky-high (or just high) interest rates aren't all bad, though. If you're not looking to borrow a lot of money -- such as if you have already locked down a reasonably low rate on your mortgage -- you can benefit from the steep rates. Your savings account at your local bank, for example, will be paying you a lot in interest, as will CDs that you buy. If possible, you'd do well to lock in high CD or bond rates by buying some long-term investments. Park $50,000 in something that pays you 10% annually and you'll collect a whopping $5,000 in just the first year!

And what of the stock market? Well, if you can collect 8% or 10% annually in interest, you might just ignore the stock market, where returns are far less guaranteed and where long-term average returns aren't likely to be much more than 10%.

Interest rates matter -- a lot. Keep abreast of them and plan your financial life accordingly.