Factors that Contribute to Your Mortgage Interest Rate

Factors that Contribute to Your Mortgage Interest Rate

 

There are many factors that contribute to your mortgage interest rate. For the average homebuyer, tracking mortgage rates helps reveal trends. But not every borrower will benefit equally from today’s current mortgage rates.

Home loans are personalized to each borrower. Your credit score, down payment, loan type, loan term, and loan amount will influence your mortgage or refinance rate.

It is also possible to negotiate mortgage rates. Discount points can provide a lower interest rate in exchange for paying cash up front.

Let’s take a look at some of these factors individually:

 

Your Credit Score

A credit score above 720 will open more doors for low-interest-rate loans, though some loan programs such as USDA, FHA, and VA loans can be available to sub-600 borrowers, but it may require a 10% down payment!

If possible, give yourself a few months or even a year to improve your credit score before borrowing. You could save thousands of dollars through the life of the loan.

If needed, we can recommend a few credit repair services.

 

Down Payment

A higher down payment can reduce your interest rate.

Most mortgages, including FHA loans, require at least 3 or 3.5% down. VA loans and USDA loans are available with zero down payment, but are subject to qualification. If you can put 10, 15, or even 20% down, you might qualify for a conventional loan with low or no Private Mortgage Insurance (PMI) and seriously reduce your monthly payments.

 

Loan Type

The type of mortgage loan you use will affect your interest rate. However, your loan type hinges on your Credit Score, making these two factors are very intertwined.

For example, with a credit score of 580 you may qualify only for a government-backed loan such as an FHA mortgage. FHA loans have low interest rates, but come with a Mortgage Insurance Premium (MIP) no matter how much money you put down.

A credit score of 620 or higher might qualify you for a conventional loan, and depending on your down payment and other factors potentially get you a lower interest rate.

Adjustable-Rate Mortgages (ARMS) traditionally offer lower introductory interest rates compared to a 30-year fixed-rate mortgage. However, those rates are subject to change after the initial fixed-rate period. An initially low ARM rate could rise substantially after 5, 7, or 10 years.

 

Loan Term

In this post we have tracked rates for 30-year fixed-rate mortgages. But 15-year fixed-rate mortgages tend to have even lower interest rates.

With a 15-year mortgage, you would have a higher monthly payment because of the shorter loan term. But throughout the life of the loan, you would save a lot in interest charges.

If you took out a $300,000 home loan with a 30-year fixed rate of 5.5%, you would pay around $313,000 in total interest over the life of the loan. The same loan size with a 15-year fixed rate of just 5.0% would cost only $127,000 in interest, saving you around $186,000 in total.

 

Loan Amount

Rates on unusually small mortgages, a $50,000 home loan, for example tend to be higher than average rates because these loans are less profitable for the lender.

Rates on a jumbo mortgage are normally higher, too, because lenders have a higher risk of loss. But jumbo loan rates have reversed course and stayed below conforming rates in 2022, creating great deals for jumbo loan borrowers.

 

Discount Points

Discount points are a form of prepaid interest or fee that mortgage borrowers can purchase to lower the amount of interest on their subsequent monthly payments—spending more up front to pay less later, in effect. Discount points are tax deductible.

• Discount points are a one-time fee, paid up front either when a mortgage is first arranged or during a refinance.
• Each discount point generally costs 1% of the total loan and lowers the loan’s interest rate by one-eighth to one-quarter of a percent.
• Points do not always have to be paid out of the buyer’s pocket; they can sometimes be rolled into the loan balance or paid by the seller.
• Buying points is a good option if a borrower intends to hold a mortgage for a long period of time, but are less useful if a borrower intends to sell their property or refinance before the loan matures.

For a $200,000 loan, a discount point would cost $2,000 upfront. However, the borrower would recoup the upfront cost over time thanks to the savings earned by a lower interest rate.

Since interest payments play out over time, a buyer who plans to sell the home or refinance within a couple of years should probably skip the discount points and pay a higher interest rate for a while.

Some rate quotes assume the home buyer will buy discount points, so be sure to check before closing on the loan.

 

Other mortgage costs to keep in mind

Remember that your interest rate is not the only number that affects your mortgage payment.

When you are estimating your home buying budget, you also need to account for:

• Down payment
• Closing costs
• Discount points (optional)
• Private mortgage insurance (PMI) or FHA mortgage insurance premiums (MIP)
• Homeowners insurance
• Property taxes
• HOA dues (if buying in a homeowner’s association)

When you get pre-approved, you will receive a document called a Loan Estimate (LE) that lists all these numbers clearly for comparison.

You can also use a mortgage calculator with taxes, insurance, and HOA dues included to estimate your total mortgage payment and home buying budget.

 

When to lock your mortgage rate

Remember that average mortgage rates are only a general benchmark. If you have good credit and strong personal finances, there is a good chance you will get a lower rate than what you see in the news. So, check with us to see what you qualify for.

If you get a good mortgage rate quote today and a payment you are happy with, do not hesitate to lock it in.