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What Affects Your Mortgage Rate

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Shopping around for the best possible mortgage rates and terms is a critical part of the home buying process. Even a seemingly tiny difference of just 1/2 of a percentage point can change your debt burden by tens thousands of dollars over the life of the loan. For example, if you take out a 30-year fixed mortgage loan on an $800,000 house with a 10% down payment at 5.5% interest vs. 6% interest rate, you could save more than $82,000 over the life of the loan! This number may vary depending on your personal circumstances. Try this online tool to see how small changes in the interest rate can affect your overall payment.

Mortgage rates can be a bit of a mystery—especially for first-time homebuyers—so here’s an overview of the most important factors.

1. Credit Score

Your credit score is the most crucial factor in determining your mortgage interest rate. A credit score is a numerical representation of your creditworthiness, and it is used by lenders to determine the likelihood of you paying back your loan. The higher your credit score, the lower your interest rate will be.

If you have a credit score of 760 or higher, you can expect to receive the best rates. However, if your score falls below 620, you may struggle to find a lender willing to work with you. In this case, you may need to consider other options, such as a government-backed loan.

2. Loan Amount and Down Payment

The amount you borrow and the size of your down payment also play a significant role in determining your mortgage interest rate. Generally, the larger your down payment, the lower your interest rate will be. This is because a larger down payment reduces the lender's risk of loss.

The amount you borrow will also affect your interest rate. Larger loans often come with higher interest rates, as the lender takes on more risk.

3. Loan Term

The interest rate is also affected by the term of your loan, i.e. the length of time you have to repay it. In general, shorter loan terms come with lower interest rates, while longer loan terms come with higher rates.

This is because for the lender the risk increases with the length of the term. The longer the loan term, the more time there is for the borrower's financial situation to change, making it more challenging to predict their ability to repay the loan.

4. Type of Loan

There are several different types of mortgage loans available, and the interest rates tend to vary by the loan type. For example, a fixed-rate mortgage will have a higher interest rate than an adjustable-rate mortgage (ARM) initially, but the interest rate on an ARM can change over time.

Government-backed loans, such as FHA loans or VA loans, often have lower interest rates than conventional loans. However, they may also come with additional fees and requirements.

5. Property Type and Location

Lenders consider the risk associated with the property type and location when determining the interest rate. For example, if you are purchasing a vacation home or an investment property, you can expect to pay a highe interest rate. Similarly, you may be charged a higher interest rate if the property is located in an area with a high risk of natural disasters or a declining housing market.

6. Debt-to-Income Ratio

Your debt-to-income (DTI) ratio is a measure of your monthly debt payments compared to your monthly income. Lenders use this ratio in their estimation of your ability to repay the loan. A lower DTI ratio generally means a lower interest rate.

For example, if you have a DTI ratio of 36% or less, you can expect to receive the best rates. However, if your DTI ratio is above 43%, you may struggle to find a lender willing to work with you.

7. Employment History and Income

Your employment history and income are also important to lenders when determining your mortgage interest rate. They want to ensure that you have a stable source of income to allow you to repay the loan.

8. Market Conditions

Finally, market conditions have a huge impact on mortgage interest rates. Interest rates are influenced by the overall health of the economy, inflation, the Fed’s policies, and other factors. Check out our market reports page to learn more.

© This article is copyrighted by Kana Nur-tegin. All rights reserved.

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