When searching for a lender to borrow a mortgage from, most borrowers will gravitate toward the lender that offers the lowest mortgage interest rate. A low-interest rate means a less-expensive monthly payment and the borrower will be saving money over the life of the loan. But understanding how mortgage rates are determined can help a borrower determine several aspects like if they have a good chance of being approved, or why they might have been denied. Let’s take a look at several factors that help determine a mortgage rate.
What factors influence mortgage interest rates?
1. Credit score
Perhaps one of the largest contributors to a mortgage rate is the borrower’s credit score and report. A credit score is a summary of your borrowing history, including any late payments, inquiries, and credit cards or loans. The purpose of a credit score is to give a lender an idea of how risky a particular borrower is, and the less risky the borrower, the higher the credit score. Typically, a borrower with a high credit score will be awarded a lower interest rate by a lender.
Before applying for a mortgage, you should take a look at their credit report, which can be obtained for free every 12 months from credit bureaus. Once you’ve received your credit report, it’s important to make sure there are no discrepancies on your report and that everything is accurate. If you come across incorrect reports on your history, your next step is to dispute those with the credit bureaus to ensure your report is accurate when the lender takes a look at it.
Interest rates can vary depending upon the location of the property you are looking to purchase. These variables include the state and whether the property is in an urban or rural area. There are a few reasons location can have a large influence on the interest rate you may qualify for. One reason is states have different foreclosure laws, which can greatly affect how the borrower can foreclose on a defaulted property. Next, other borrowers in the area actually influence the rate because lenders will take into consideration the rate at which homeowners default in the area.
3. Home price
If the price of the home is high or low, that can affect the interest rate your lender offers you. A high loan amount can be considered more of a risk from the lender perspective, therefore raising the interest rate.
4. Down payment
A common pattern seen within the home buying experience is the higher the down payment provided, the lower the interest rate. A lender can view a borrower as a lower risk if they’re putting more toward the home upfront, which will decrease the amount of funds that will be borrowed. If the lender if giving less money toward a property, this is considered lower risk and is favorable in the eyes of a lender. Those providing a 20% down payment on a home may qualify for a lower rate than a borrower who is only providing 5% down. Additionally, if you put down less than 20%, you will be required to pay Private Mortgage Insurance (PMI) and that will also increase your overall payment.
5. Current interest rates in the market
The housing market and the Federal Reserve also affect home loan rates. The Fed doesn’t set mortgage interest rates, but they set federal fund rates which are the rates financial institutions will lend funds to one another. The more expensive a federal fund rate is, the more costly it will be for one institution to borrow from another. This can cause an increase in interest rates on products such as mortgages in order to accommodate the higher federal fund rates.
6. Length of mortgage
Typically, shorter-term mortgages are accompanied by a lower interest rate. This, again, has to do with how risky a borrower is who needs a longer-term. If a borrower chooses a 30-year length, this gives a longer amount of time for the borrower to potentially default on the loan. Whereas a 10-year or 15-year loan would be considered lower risk.
7. Type of loan
Common types of mortgages include Conventional, Jumbo, VA, FHA and USDA. Interest rates vary among types of loans because they have different qualification requirements. For example, most jumbo loans will require at least a 10% down payment, while most conventional loans allow as little as 3% down. Additionally, loans like VA, FHA, and USDA are government-insured loans with their own eligibility standards. These major differences among the loans can have a significant impact on the interest rate you may qualify for.
The bottom line
There are many variables that go into determining mortgage interest rates and understanding the factors can help you choose the best mortgage product for you. It’s important to remember your mortgage interest rate could be determined by any combination of these factors. The best way to determine what your rate will be is to consult with one of our expert loan officers.
As always, we’re here to answer any questions you have and help guide you through the process. Give us a call or start your application today.
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