Understanding Mortgage Rates
Mortgage rates affect home affordability and long-term costs. Rates vary by economy, loan type and borrower credit. Lower rates can save money.
NEW YORK — Buying a home is the most expensive purchase many people make in their lifetimes. Some people do it only once, while others are in the market with greater frequency. In any instance when the home buying process involves securing a mortgage, buyers can benefit from knowing a thing or two about mortgage interest rates.
A mortgage interest rate can help buyers determine if a given home is affordable or beyond their budget. Rocket Mortgage says mortgage interest rates can have a major impact on long-term costs, so it is imperative to seek the lowest rates possible.
However, an assortment of economic variables affects mortgage rates, and conditions unique to each buyer also can affect the rate they're eligible to obtain. Understanding home loan rates can help potential buyers better navigate the complex process of buying a home.
What is mortgage interest? When a person buys a home with a mortgage, he or she doesn't just pay back the amount borrowed, which is called the principal. The loan also requires paying interest, which is essentially the cost of borrowing money. Mortgage interest is calculated as a percentage of the remaining principal, says Investopedia.
How are mortgage rates set? Mortgage rates are not determined by a single variable. They are derived from a combination of factors that includes the Federal Reserve's monetary policy, economic conditions and a borrower's personal financial situation.
The Federal Reserve in the U.S. influences the overall rates by adjusting the federal funds rate, or the rate at which banks lend to each other overnight. This not only impacts mortgage rates, but also additional interest rates, according to Fannie Mae. Lenders will ultimately decide on the specific rates to offer borrowers.
How does a borrower's financial situation affect mortgage rates? Lenders will conduct a thorough assessment of a potential borrower's creditworthiness. They will look at, among other things, a borrower's credit score and debt-to-income (DTI) ratio. A higher credit score typically results in a lower interest rate.
A lower DTI indicates a lower risk to the lender, also potentially resulting in a lower interest rate. Squaring away finances well in advance of applying for a mortgage can help home buyers secure lower interest rates that could save them considerable sums of money over the life of their mortgages.
How do loan types affect mortgage interest? A home buyer will pay interest no matter the mortgage type, but there are options to select a fixed or adjustable interest rate, or even interest-only mortgages.
According to Bankrate, with a fixed-rate mortgage, the interest rate remains the same throughout the life of the loan, meaning the payment for principal and interest will remain consistent. Additional charges that are wrapped into mortgage payments could change, however.
Property taxes and homeowners' insurance charges could increase, for example. Fixed rates tend to be lower when the term of the mortgage is shorter. So, borrowers can opt for a 20-year mortgage over a 30-year to save some money on interest.
An adjustable-rate mortgage will see the interest rate change during the repayment period. It may start with a low introductory rate for the first several years of the loan but then can go up or down depending on market indexes and benchmarks. Many lenders put a cap on how high the interest rate can go, however.
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