Home Mortgage Rates – 6 Key Factors
August 17, 2010
Home mortgage rates offered by your bank can vary from person to person; what determines the interest rate you’re eligible for?
While the interest rates on 10 year Treasury notes have a major impact on whether mortgage rates rise or fall, there are many individual factors that go into determining your interest rate. Those individual factors are measurements banks can use to help calculate the amount of risk they take on if they give you a home loan. Let’s take a look at six of the main factors that typically figure into your home mortgage rate.
1) Loan Amount: The bigger your loan amount, the larger the risk of default. A larger mortgage usually means bigger payments, and that means a bigger stress on your budget. If you are getting a jumbo mortgage, the increased risk can be reflected in a higher interest rate.
2) Amortization Schedule: When you borrow money, a schedule is created for repayment that’s known as an amortization schedule. It reflects how much of each payment goes toward interest and how much goes toward principal each month, in addition to determining when the loan will be paid off.
If you have a longer loan term, it means that you build equity (or ownership) in your home at a slower rate. A long mortgage term also means that you have more time to default. If you are willing to pay off your mortgage faster, you will likely see a lower interest rate.
3) Credit Score: You probably knew this was coming. Whether or not you think the credit scoring system is fair, the fact is that mortgage lenders use this system to evaluate your level of fiscal responsibility.
Your credit score is a reflection on your past behaviors related to borrowing money. A lower score means that there is a greater risk that you will default on the mortgage, or be late in paying. In order to make up for that, you will have to pay a higher mortgage rate. A good credit score can save you thousands of dollars (even tens of thousands of dollars) in interest charges. You can read more on how your credit score affects interest rates.
4) Loan-to-Value Ratio: This number represents the amount of money you owe on your mortgage as compared to the value of the home. If you have a home that is worth $200,000 and owe $170,000, your loan-to-value ratio is 85%.
Many lenders consider a loan-to-value ratio of 80% or less to represent an more favorable situation, since it represents an amount of equity in the home that reduces the impact on the lender if your home ends up in foreclosure.
If you have a 20% down payment, you automatically get to the desired loan-to-value ratio, and can usually see a lower interest rate. When applying for a refinance or a home equity loan, a desirable loan-to-value ratio will also help you with a lower interest rate.
5) Loan Type: The type of loan you are getting matters as well. A variable rate loan, like an adjustable rate mortgage, generally starts out a little lower than a fixed rate loan, since the bank is hoping that interest rates will go up — meaning more money down the road.
A cash-out refinance loan generally carries a higher interest rate than a purchase mortgage, since a cash-out means you are taking more out against your home’s equity; this results in a greater risk for the lender.
A home equity line of credit that you tap repeatedly may have a variable rate, or a higher interest rate, as opposed to a fixed-rate home equity loan that is perceived as offering less risk.
6) Loan Program: Whether you’re borrowing using an FHA loan vs a conventional loan can affect your mortgage interest rate. An FHA loan, guaranteed by the government, often has a lower interest rate than a conventional loan. This is because the FHA insures the loan, reducing the risk to the lender. So, you might get a better rate than you would get under normal circumstance if you qualify for certain loan programs.
In the end, the mortgage rate you end up with is all about the risk to the lender. A mortgage lender considers the facts of the loan, and then makes a decision on your interest rate based on how likely you are to default, and the amount of equity the home would have to cushion the costs associated with foreclosure.
Your Interest Rate
These 6 factors aren’t the hard and fast rules for an interest rate calculator for every bank; each lender uses their own set of standards and these are some of the most common. You can use them to estimate whether you’ll get a high or low interest rate relative to the market but the only real way to find out the mortage rate you can borrow money at is to fill out a mortgage application and get pre-approved for a specific loan amount.
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