Seven factors that determine your mortgage interest rate
Your lender knows how your interest rate gets determined, and we think you should, too. Learn more about the factors that affect your interest rate.
By Nicole Shea – SEP 29, 2017
Knowing what factors determine your mortgage interest rate can help you better prepare for the homebuying process and for negotiating your mortgage loan.
How much will you pay in interest on your mortgage loan?
1. Your credit score is one factor that can affect your interest rate. In general, consumers with higher credit scores receive lower interest rates than consumers with lower credit scores. Lenders use your credit scores to predict how reliable you’ll be in paying your loan. Credit scores are calculated based on the information in your credit report, which shows information about your credit history, including your loans, credit cards, and payment history.
Before you start mortgage shopping, your first step should be to check your credit, and review your credit reports for errors. If you find any errors, dispute them with the credit reporting company. An error on your credit report can lead to a lower score, which can prevent you from qualifying for better loan rates and terms. It can take some time to resolve errors on your credit reports, so check your credit early in the process.
If you don’t know your credit scores, there are many ways to get it. Learn more about things you can do to raise your credit scores.
2. Home location
Many lenders offer slightly different interest rates depending on what state you live in.
Different lending institutions can offer different loan products and rates. Regardless of whether you are looking to buy in a rural or urban area, talking to multiple lenders will help you understand all of the options available to you.
3. Home price and loan amount
Homebuyers can pay higher interest rates on loans that are particularly small or large. The amount you’ll need to borrow for your mortgage loan is the home price plus closing costs minus your down payment. Depending on your circumstances or mortgage loan type, your closing costs and mortgage insurance may be included in the amount of your mortgage loan, too.
If you’ve already started shopping for homes, you may have an idea of the price range of the home you hope to buy. If you’re just getting started, real estate websites can help you get a sense of typical prices in the neighborhoods you’re interested in.
4. Down payment
In general, a larger down payment means a lower interest rate, because lenders see a lower level of risk when you have more stake in the property. So if you can comfortably put 20 percent or more down, do it—you’ll usually get a lower interest rate.
If you cannot make a down payment of 20 percent or more, lenders will usually require you to purchase mortgage insurance, sometimes known as private mortgage insurance (PMI). Mortgage insurance, which protects the lender in the event a borrower stops paying their loan, adds to the overall cost of your monthly mortgage loan payment.
As you explore potential interest rates, you may find that you could be offered a slightly lower interest rate with a down payment just under 20 percent, compared with one of 20 percent or higher. That’s because you’re paying mortgage insurance—which lowers the risk for your lender.
It’s important to keep in mind the overall cost of a mortgage. The larger the down payment, the lower the overall cost to borrow. Getting a lower interest rate can save you money over time. But even if you find you’ll get a slightly lower interest rate with a down payment less than 20 percent, your total cost to borrow will likely be greater since you’ll need to make the additional monthly mortgage insurance payments. That’s why it’s important to look at your total cost to borrow, rather than just the interest rate.
Make sure you are factoring in all of the costs of your loan when you are shopping around to avoid any costly surprises. Different down payment amounts will affect both your mortgage interest rate and the amount of interest you’ll pay over the life of the loan.
5. Loan term
The term, or duration, of your loan is how long you have to repay the loan. In general, shorter term loans have lower interest rates and lower overall costs, but higher monthly payments. A lot depends on the specifics—exactly how much lower the amount you’ll pay in interest and how much higher the monthly payments could be depends on the length of the loans you're looking at as well as the interest rate.
The length and rate of your loan would affect your interest costs.
6. Interest rate type
Interest rates come in two basic types: fixed and adjustable. Fixed interest rates don’t change over time. Adjustable rates may have an initial fixed period, after which they go up or down each period based on the market.
Your initial interest rate may be lower with an adjustable-rate loan than with a fixed rate loan, but that rate might increase significantly later on. The interest rate types affects interest rates.
7. Loan type
There are several broad categories of mortgage loans, such as conventional, FHA, USDA, and VA loans. Lenders decide which products to offer, and loan types have different eligibility requirements. Rates can be significantly different depending on what loan type you choose. Talking to multiple lenders can help you better understand all of the options available to you.
One more thing to consider: The trade-off between points and interest rates
As you shop for a mortgage, you’ll see that lenders also offer different interest rates on loans with different “points.”
Generally, points and lender credits let you make tradeoffs in how you pay for your mortgage and closing costs.
Points, also known as discount points, lower your interest rate in exchange for an upfront fee. By paying points, you pay more upfront, but you receive a lower interest rate and therefore pay less over time. Points can be a good choice for someone who knows they will keep the loan for a long time.
Lender credits might lower your closing costs in exchange for a higher interest rate. You pay a higher interest rate and the lender gives you money to offset your closing costs. When you receive lender credits, you pay less upfront, but you pay more over time with the higher interest rate. Keep in mind that some lenders may also offer lender credits that are unconnected to the interest rate you pay—for example, a temporary offer, or to compensate for a problem.
There are three main choices you can make about points and lender credits:
You can decide you don’t want to pay or receive points at all.
You can pay points at closing to receive a lower interest rate.
You can choose to have lender credits and use them to cover some of your closing costs but pay a higher rate.
Learn more about evaluating these options to see if points or credits are the right choice based on your goals and financial situation.
Now you know
It’s not just one of these factors—it’s the combination—that together determine your interest rate. Everyone’s situation is different, based on your personal factors. Read this article in its entirety here https://www.consumerfinance.gov/about-us/blog/7-factors-determine-your-mortgage-interest-rate/
By understanding these factors, you’ll be well on your way to shopping for the right mortgage loan—and interest rate—for you and your situation. Not all of these factors are within your control. But understanding how your mortgage interest rate is determined will help you be more informed as you shop for a mortgage.
Interest rates fluxuate, and these factors mentioned here change. Some lenders can work with investors to fund loans and can take on riskier loans like job changes, student loans, etc.
Connie is a Realtor®️ In Central Ohio and works with sellers and buyers to make their home sale and purchase smoother and on time. She can be reached at 614-943-0025