Are you looking to purchase a home but you’re worried about your interest rate? It may be easy to find out what the average current interest rate is, but how is the actual rate determined when you apply for a home loan? Cliffco Mortgage Bankers is here to answer all of these questions.
First, a lender starts with the overall market levels, which are determined by the economy and the Federal Reserve. Generally speaking, a bad economy produces lower mortgage rates, and a good economy produces higher rates. Lenders also take into consideration several other factors that help them arrive at a final interest rate for the applicant. Since even a fraction of a point can significantly raise or lower your monthly payment amount, those factors tend to hold a great deal of weight. Here’s a glimpse into all the different elements that influence a borrower’s interest rate.
The Borrower’s Financial Standing
Lenders run a credit report on each applicant so they can find out about their credit history. Credit scores are the most reliable indication of how financially responsible a borrower is and whether they pay their bills on time. Borrowers with the highest credit scores are often rewarded with the lowest interest rates.
Loan Type and Term
The type and length of the mortgage you are applying for will have an impact on your interest rate. For instance, a conforming loan will typically have a lower interest rate than a non-conforming, or jumbo loan. In the continental United States, a loan is considered jumbo if it exceeds $625,500.
In addition to conforming and non-conforming, most lenders also offer both fixed and variable rate loans. Fixed rate loans have a mortgage rate that is locked in for the life of the loan, so the monthly payment is the same each month. With a variable or adjustable rate mortgage (ARM), the interest rate can rise and fall with the market, so the payment fluctuates from month to month. One of the benefits of a variable rate loan is that borrowers are charged a lower rate for them since they are less risky for the lender.
The term, or length, of the loan is also a consideration. Those who opt for a shorter term such as a 15-year loan are usually given a lower interest rate since the shorter term means less risk for the lender. Borrowers who choose these mortgages appreciate the lower interest rate since they will be making higher monthly payments in order to pay off the loan in a shorter time period.
Owner-Occupied vs. Investment Property
If borrowers apply for a mortgage on a property that they either currently live in or plan on living in once a purchase is complete, they will usually pay a lower interest rate than if they were applying for a loan on an investment property. Since an investment property is usually rented out to tenants, lenders see it as a higher risk.
Positive vs. Negative Points
Many lenders give borrowers the opportunity to pay money up front in order to get a lower interest rate. This is referred to as “buying down” with discount points, which are also called positive points. A point is equal to one percent of the total loan amount. One positive point has the potential reduce the interest rate by approximately 0.25%.
In situations where a borrower isn’t willing or cannot afford to pay the closing costs associated with obtaining a mortgage, the lender will sometimes pay those costs in exchange for a higher interest rate. Also known as “negative points,” this can eliminate up-front closing costs, however because of the higher interest rate, the borrower will pay those costs over the life of the loan.
If you are looking to purchase a home in the near future and need guidance on what type of loans you can afford, please contact Cliffco Mortgage Bankers where one of our licensed mortgage consultants will be happy to assist you.