Interest rates level off after spring's surprising jump

For nearly 10 months interest rates moved up a little, then down a little, but the average cost for most types of mortgages remained below 6.5%.

Then rates unexpectedly took off in late May, making home loans more expensive than they've been since, well, this time last year.

Our most recent survey of major lenders taken July 3 found the average:

30-year fixed-rate loan -- the most popular way to pay for a house -- costs 6.78%.

15-year fixed-rate loan costs 6.46%.

30-year jumbo loan (for more than $417,000) costs 7.02%.

That means payments would be $650 a month for every $100,000 borrowed with the average 30-year, fixed-rate loan. That's just $6 a month less than you'd have paid in July 2006 but $38 a month more than in mid-March when interest rates were below 6.2%.

Adjustable rate mortgages have also risen since May. Our survey found a 30-year ARM with an initial rate guaranteed for:

Five years costs 6.54%.

One year costs 6.27%.

The difference in rates between ARMs and fixed-rate loans what lenders call the spread remains much smaller than usual.

Opting for a five-year ARM only saves $15 a month, not enough for most buyers to risk rates and payments going up when those loans begin resetting. That's why only one in 10 homes are being purchased with ARMs and the great majority of homeowners with ARMs are choosing fixed-rate loans when they refinance.

What's behind the sudden surge in mortgage rates? Recent reports that wages and other labor costs are growing faster than expected have lenders and investors worried that inflation is getting out of control again.

Although the Consumer Price Index rose 2.5% in 2006, higher energy and food prices have pushed prices up at a 5.5% annual rate during the first five months of the year.

The last time inflation was that high, the Federal Reserve launched a two-year campaign to raise interest rates on all types of consumer loans. (The idea is that pricier loans will cause us to spend less, making it harder for businesses to raise prices on everything from cars to haircuts.)

Interest rates have stabilized over the past couple of weeks and, if borrowers are fortunate, they've peaked and may drift lower over the next couple of months. That's what happened last summer after 30-year fixed-rate loans topped out at 6.93% the last week in June.

Freddie Mac -- the government-chartered company that buys mortgages from lenders originally predicted 30-year fixed rate loans would average 6.2% this year and 6.4% in 2008. Now it's saying rates will remain about where they are now for the rest of the year.

Our extensive database of the best mortgage rates from across the country shows a few lenders still offering borrowers with good credit loans of 6.375% with fees of $1,000 or less, but most are now up to 6.625%.

That's certainly not as cheap as four summers ago when 30-year rates bottomed out at 5.28% -- the lowest they've been since Interest.com (and its print predecessors) began its weekly survey of major lenders in 1985.

But it's less than the 7% or 8% we were paying during the mid- to late-'90s, and the double-digit rates we were charged throughout the '80s and early '90s.

The recent surge will be a more serious burden for borrowers with poor credit scores of 620 and lower -- who must pay higher than average interest rates.

Lenders are already making subprime mortgages harder to obtain after an alarming increase in the number of defaults and foreclosures. Applicants who would have had little trouble qualifying just a few months ago are being turned away because they don't make enough money, or have too much debt, to meet stringent new requirements.

Another big and very sudden change is that 100% financing has virtually disappeared for subprime borrowers. Last year about one out of every three subprime borrowers was given enough to cover the full purchase price of their homes. Now you'll need a down payment that covers at least 3%, if not 5% or more, of the price.

The Mortgage Bankers Association has projected 30% fewer subprime loans will be made this year and that was before rates began their surprising climb.

By Mike Sante

Interest.com Managing Editor

Have a question about your finances? Ask us at editors@interest.com

Inside Mortgages Weekly Column

Interest rates level off after spring's surprising jump