How Your Mortgage Interest Rate is Determined

Mortgage rates are usually discussed in broad strokes– they’re up, down, fixed or adjustable — but it’s important to understand mortgage rates in context. Prospective homebuyers love to ask about rates. They think they will receive the same low rates advertised in newspapers. They don’t know that rates are as individual as fingerprints. To help your buyers understand how their interest rate is determined, we put together a list of the Top 9 Factors Determining Your Mortgage Interest Rate. Please share this with your buyers so they are better informed.

FICO Score

Everyone knows good credit is important, but you do not need perfect credit to qualify for a mortgage. Lenders use the middle score of all three of your credit bureau reports from TransUnion, Experian and Equifax. Because each company calculates credit differently, your scores will not match. Accounts may be missing from one credit bureau, but shows up on another. For this reason, lenders throw out the highest and lowest score and base your rate on your mid-score. The higher your mid-score, the lower your mortgage rate will be.

Home Location

Location tends to get overlooked while rate shopping, but where you buy also determines your mortgage interest rate. Most lenders offer a different rate based on your city and state. States with easy foreclosure processes have lower rates than states that make banks jump through hoops to take back the property after a borrower defaults. Likewise, states with booming economies are priced higher than states that need a little economic stimulus.

Property Type

If you’re buying a condo, your rate will be different than if you buy a single-family detached home.  Every property type has its own pricing. Mobile homes are priced differently than town homes which are also priced differently than single family homes. This is not something to worry about, but it is a factor in determining your rate.

Loan Amount

The more you put down, the lower your interest rate, that’s the rule of thumb. Take your purchase price, subtract your down payment amount, the balance is the amount you will borrow — your loan-to-value or LTV.  Borrowers who put down 20% are considered less risky and therefore given discounts, but the size of the loan matters. It is just as expensive for a lender to write a small loan as it is to write a large one so lenders price small loans higher than jumbo loans. Likewise, some lenders may not want loans that are too small because if may not be worth the expense of writing the loan.

Down Payment

It’s not necessary to put down 20% on a home purchase. There are many loan products that allow lower down payments. FHA loans allow 3.5% down payments; VA loans do not require a down payment while Fannie Mae and Freddie Mac recently introduced 3% down loan products. All are competitively priced so there is no need to fear moving forward with a government-backed loan product.

Loan Type

Conventional, FHA, VA, subprime — all of these are loan types. Rates for loan types vary based on your lender’s financial goals, and the risk associated with the loan type.

Occupancy Status

If you’re an investor and do not plan to live in the property, you will pay a higher rate than someone who is purchasing their primary residence. Vacation homes, rental properties are all priced higher because they are riskier investments for the bank.

Interest Rate Type

A 30-year fixed rate mortgage is now the standard, most popular mortgage product written, but it’s also the most expensive. Adjustable rate mortgages offer substantial discounts, but only for a limited time. If you’re looking for stability with no surprises, a 30-year fixed is the way to go. If you recently relocated and may not stick around for long, or if you just got married and know you plan to start a family so you will probably outgrow your starter condo in about five years, then an adjustable rate mortgage might make more sense.

Mortgage Term

Once you decide if you want a 30-year-fixed or an adjustable rate, it’s time to consider loan terms. The shorter the term, the less you pay overall. However, shorter loan terms also mean higher monthly payments.

No matter what type of interest rate you choose, or where you decide to buy, the goal is to become a homeowner. As rents push to record high levels, owning makes financial sense. No matter what rate you get today, you can always refinance.

Reprinted with permission from Partner Exchange