Are you in the market for a new home? If you are, you’re probably also shopping around for the best mortgage rate. How can you be sure that you’re getting the best deal? Understanding what a mortgage rate is and how it is determined can help you figure out how to secure the best rate possible.
A mortgage rate is the interest rate you pay your mortgage lender, and it determines how much you will end up paying for the property. The higher the interest rates, the more you are going to pay overall. Mortgage rates are calculated by the lender based on the current economic status (which you have no control over) and personal factors like credit score, occupancy, size of the loan, down payment, and more. We’ll break down the different types of mortgage rates you might select, as well as steps you can take to get the best rate possible.
What Are The Different Types of Mortgage Rates
Most of the time when shopping for a mortgage, you’ll be choosing between a fixed-rate mortgage and an adjustable-rate mortgage. With a fixed-rate mortgage, you will pay a fixed monthly interest until you clear the loan. Fixed-rate mortgages offer higher interests from the start, but you will enjoy certainty and consistency.
The interest rates of adjustable-rate mortgages change within the repayment period. You will start by paying low-interest rates for the first seven or ten years, but the interest will increase over time depending on the economic conditions. Adjustable-rate mortgages have lower introductory interest rates, but the amount increases after some time, which could land you in a pinch if you do not have a flow of income that will accommodate your rising rate.
How Are Mortgage Rates Set?
Mortgage rates are set using market factors like federal rates, and personal factors like your credit score. The lender uses these factors to assess the risk level of the loan, or in other words, the likelihood that you won’t be able to pay back what they lend you. This assessment determines the mortgage rate they will offer you. Below are some factors that determine how mortgage rates are set.
1. Mortgage Bond Market
We all know that banks make money on our mortgages, but mortgages aren’t just simple loans that your bank makes to you and then profits from via interest. Instead, banks package mortgages into mortgage-backed securities (MBS) and sell them to investors, acting as a middleman.
Just like many other forms of investing, investors make decisions about what to purchase based on how risky the investment seems. In this case, a stable housing market in a good economy makes investments seem less risky, and so investors will be willing to buy MBSs at lower interest rates. If the market is shaky or inflation is on the rise, investors will be looking for higher interest rates to justify the risks. And this is one of the things that will determine the interest you pay on your mortgage
2. Your Credit History
Your credit history plays a significant role in determining the mortgage rate you receive. Your credit score tells the lender how much risk they are taking to lend you money—the higher your credit score, the lower the mortgage rate, and vice versa.
3. Current Market Interest Rates
The Federal Reserve sets federal fund rates, which are tools that determine the interest rates at which financial institutions borrow from each other. If the national fund rates are high, it will be expensive for banks and other financial institutions to lend to each other. This increases the interest rates of investment products like mortgages. This is out of your control, and if you need to buy a house at a time when fund rates are high, you may consider refinancing your mortgage down the line when rates are lower.
4. Length of Mortgage
Financial institutions consider long-term mortgages riskier and charge higher interest rates for them. The assumption is that a person who takes a 30-year mortgage is more likely to default, and so banks charge high-interest rates to cover the risk. On the other hand, a 10-year mortgage is considered less risky and comes with lower rates.
5. Occupancy
How you plan to use the house plays a significant role in determining your mortgage rate. A primary house will get a lower interest rate than an investment property, the reason for which again boils down to risk. The assumption is that if you experience a financial crisis along the way to paying off your mortgage, you will work harder to make payments for a primary house, because that is where you live, whereas you can more easily abandon a rental property that is not making you money.
Tips on How to Get the Best Mortgage Rate
As you plan to apply for a mortgage, it is crucial to examine your qualifying factors to earn you the best possible mortgage rate. The tips below will help you get the best interest rates and save you money.
1. Improve Your Credit Score
Your credit score communicates your ability to pay the debt. A low credit score might not disqualify you from getting a mortgage but brands you as a high-risk borrower, a title that earns you costly borrowing terms. On the other hand, a high credit score helps the bank trust in your repayment ability, and feel confident in giving you a lower mortgage rate.
Work to build your credit score by paying debts on time, clearing credit card balances, and getting a secured credit card if you do not have one. Check your credit reports regularly and clear any errors or mistakes before approaching your mortgage lender.
2. Make a Substantial Down Payment
Some lenders advertise that they can give you a 0% down payment mortgage, but they do not tell you that this will come with a high mortgage rate. Financial experts advise paying at least 20% of the cost of the house in your down payment, thus reducing the amount you will need to borrow. With a 20% down payment, you are more likely to secure a lower mortgage rate and low monthly payments. This will also save you on private mortgage insurance.
3. Take a Short-Term Fixed-Rate Mortgage
Mortgage lenders can give you up to 30 year mortgages; however, if you have a good flow of income, consider a 10 or 15-year mortgage because the interest rates for short-term mortgages are lower. The monthly payments will be higher, but you will pay less for the property than a borrower who takes out a 30-year loan.
4. Consider Homebuyer Programs
The government understands that homeownership is an uphill journey for many people. In response, some states have developed programs that offer low mortgage rates or down payment grants to help citizens buy homes in specific locations. If you come across such programs, take advantage, but always confirm they are genuine before giving them your hard-earned money.
5. Compare Lenders
Never settle for the first lender you come across, even if they offer you the lowest interest rate. While it is essential to consider the lender with the lowest interest rates, other factors like ledger fees and the Annual Percentage Rate affect the total cost of a loan. Ask for quotes from at least three lenders and compare.
