8 Things That Can Affect Your Mortgage Rate
Most people buying a new home will need to borrow money from a lending institution to pay for the full cost of the house. These loans are referred to as mortgages, and like every other type of loan, they have a cost associated with them known as an interest rate. In mortgage lending, the interest rate is simply called the mortgage rate. The mortgage rate is a small percentage of the loan that you must pay every month to continue living in your home.
Interest rates of every kind, including the mortgage rate, measure the underlying risk that the loan may not be paid back. Lending institutions charge a higher rate when they perceive a higher risk of the loan not being paid back. Alternatively, they charge a lower interest rate when they perceive a lower risk of the loan not being paid back. There are various reasons that lending institutions perceive higher or lower risk when determining what your mortgage rate should be.
One of the most basic pieces of information that almost all lenders use is your credit score and credit report. Before you go in to get a mortgage, get a copy of your credit report to make sure that it’s accurate. If there are any errors that will negatively affect your credit score, get them removed from your credit report as soon as possible. Your credit report provides the lender with detailed information on the level of risk they are taking by lending you money. Your payment history, length of credit history, number of credit accounts, derogatory marks, and other information will help them determine what mortgage rate to charge you. If you plan on buying a house in the near future, monitor your credit report closely and do everything in your power to raise your credit score. The Fair Credit Reporting Act (FCRA) requires each of the three nationwide credit reporting companies (Equifax, Experian, and TransUnion) to provide you with a copy of your credit report, at no charge, once every 12 months. You can request your free copy at annualcreditreport.com.
The loan term is how long it will take you to pay your mortgage back. Shorter terms usually have lower mortgage rates. However, shorter loan terms also have higher monthly payments. The lending institution is taking on less risk because you will be paying your mortgage back much quicker. Longer loan terms have higher mortgage rates because it increases the chances that the loan may not be paid back. More unfortunate circumstances may occur over a longer period of time that may prevent you from paying your mortgage back.
A larger down payment means a lower mortgage rate because lenders perceive you as less risky when you have a higher stake in the property. The standard down payment is typically around 20% of the home value. If you can afford more than 20%, you should consider paying more. It can save you money in the long-run because less interest will accrue over time. You will also build equity in your home much faster because it will take you less time to pay off the total amount of the loan. Your home price will also be a significant factor in determining your mortgage rate. A more expensive home will come with a higher mortgage rate because it will require more money to fully pay off the loan. Get a good sense of your price range to determine what mortgage rate could be associated with the price level of your new home.
Traditional single family homes get the lowest mortgage rates because they have lower historical default rates. On the other hand, multi-family homes, condos, co-ops, and mixed-use developments have higher historical default rates, and therefore higher mortgage rates associated with them. Housing used for a vacation home or a rental also has a higher mortgage rate due to higher default rates.
Mortgage lenders have different pricing depending on what location you live in. If you are planning on moving to a different location, especially another state, check the lenders rates in that specific area. Also, larger lenders often times don't service rural areas. If you are moving to a more remote rural area, make sure and find a lender that will do business with you.
Sometimes your ability to get a lower rate depends on the time you spend shopping around. There are most likely multiple mortgage lenders in your area and you should take the time to get a quote from each one. These are competing institutions that will often have different prices for mortgages. Taking the time to get a quote from each one could save you thousands of dollars in the long-run.
Fixed Rate Mortgages have a mortgage rate that stays constant throughout the life of the mortgage and is based on the factors described above. Adjustable Rate Mortgages are based on the factors described above but the mortgage rate will also fluctuate after a given amount of time. Usually ARMs start out with a lower mortgage rate than a Fixed Rate Mortgage because you are potentially taking on more risk in the future. When the ARMs start to adjust, they adjust based on a specific market, often times the US Treasury market. Once the adjustment period starts, your new mortgage rate will be the market rate plus some margin, maybe 1% or 2%. ARMs can be risky for the borrower, as interest rates can rise significantly over the life of a mortgage. Fixed Rates can be risky for the bank, since it allows the consumer to lock in an amount that may become well below the market rate.
Interest rates fluctuate significantly over time, driven primarily by macroeconomic factors such as inflation and the overall strength of the economy. Current interest rates are near historic lows, but nobody can say for certain how long that will last. As with any investment, there is always an element of luck and timing.