What Factors Determine Mortgage Interest Rates?


Now that you’re ready to purchase a home, it’s important to understand how you can get the best interest rate for your loan. As any lender will tell you, getting the lowest possible interest rate can save you thousands over the life of your loan. But how can you get a lower rate? Here are the factors that determine your rate, and some things you can do to make sure you get the lowest possible rate.

Your Credit Score

A credit score is a 3-digit number between 300 and 850 that tells a lender the likelihood you will repay a loan. Higher numbers are better, so you want to go into any home buying experience with the highest possible credit score. Many lenders won’t be able to approve a loan if your score is less than 550, and a score below 700 will mean a higher interest rate. Your score is calculated based on a history of your loans and a payment history. This includes auto loans, credit cards, store credit accounts, student loans, and others. The less money you owe to other lenders, and the more on-time payments you make to your lenders, the higher your score will be.

Check your credit score and credit report at least 6 to 12 months before you even try to get approved for a mortgage loan. Make sure the information in it is accurate, make on-time payments on all your loans, and pay down as much debt as possible to increase your score.

Down Payment Amount

Another factor that the lender considers is the amount of your down payment. These days it’s hard to get a loan without putting any money down, but some loans (such as FHA loans) allow you to put as little as 3.5% of the loan amount down at closing, so you finance 96.5% of the home’s value. If you have the cash on hand and can put down 10 to 20% down, you will usually get a lower rate.

Your Future Neighborhood

Mortgage loan rates are based on national rates, but there can be slight differences in the exact rate you get depending on where your future home is located. For example, rural areas might have different rates from urban or suburban neighborhoods because of the complexity of loans in rural areas.

Total Loan Amount and Length

Another factor impacting your loan is the total amount you plan to borrow and for how long. Lenders may have higher rates if your loan is out of the “norm”, meaning it’s either on the very large side or the very small side of average mortgages in your area. You may be able to get a better rate for shorter loans. Generally mortgage loans are available in terms from about 10 to 30 or more years. You’ll save money on fees and interest the shorter you go, but your monthly payments will be higher.

Rate Type

There are two categories of mortgage rates: adjustable and fixed. An adjustable rate mortgage (ARM), as the name would suggest, is fixed for a certain number of years at the beginning of the loan and then will adjust based on the market rates. For that reason, ARMs usually have lower initial rates, but that rate could go up significantly later. Fixed rate loans might be higher at the beginning, but they will not change for the life of your loan so your monthly payments won’t go up.

Understanding how mortgage interest rates are determined can help you get the best possible rate for your next home loan. Talk to your mortgage lender to learn more about how all these aspects might impact your interest rate before you get a mortgage loan.

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