If there’s one thing borrowers worry about the most with a new mortgage it is the mortgage rate. It makes sense. Who wants to pay more interest than necessary? Did you know, though, there are many factors that drive this rate? Some are in your control, others aren’t. We discuss both here so you can make the most of the rates offered to you.
Factors you Can’t Control
There are some things you can’t control. These factors affect interest rates for everyone, not just you. Understanding these factors can help you determine the best time to apply for a mortgage. These factors have to do with secondary investor and the market as a whole.
Secondary investors are the people who buy your mortgage. Many times your lender doesn’t keep your mortgage. They fund it and then sell it right away. The people who buy it are the investors. They are the ones that have an impact on the underwriting rules. They also have an impact on the interest rate.
The largest players in the secondary market are Fannie Mae and Freddie Mac. You have likely heard of them. They buy mortgages, pool them together and sell them to investors. There are also private investors out there. However, Fannie and Freddie are the most common. As Fannie Mae and Freddie Mac buy mortgages off a lender’s hands, the lender can then lend money to other borrowers. Without their help, there would be fewer mortgages.
The willingness of the investors is part of what drives interest rates. Generally, you can expect rates to rise when:
- Stock prices increase
- Foreign markets do well
- Unemployment rates are down
- Inflation increases
In general, when the economy is doing well, you can expect mortgage rates to increase. Investors want to invest their money elsewhere when things are good. This means a smaller pool of investors. With higher rates, though, they may be enticed to invest.
On the other hand, you can expect interest rates to fall when:
- Stocks plummet
- Jobs are scarce
- Inflation slows down
- Foreign markets are in trouble
Lower interest rates help borrowers afford new mortgages. It also gives investors something to purchase that is not as risky as stocks or bonds.
As you can see, you have no impact on any of these factors. It’s just the way of the world and you have to see how you fit in.
Factors you Can Control
Now, there are some factors you can control. These pertain to your individual financial picture. The lower risk you provide a lender/investor, the lower your mortgage rate.
The number one factor is your credit score. This little number tells lenders a lot about you. It lets them know how financially responsible you are. The lower your score, the riskier you are. This usually means a higher interest rate, if the lender does approve your loan. Work on perfecting your credit score before applying for a mortgage to get the best interest rate available to you.
Another important factor is the amount of your down payment or your loan-to-value ratio. The more you borrow, the higher your LTV. A higher LTV means a riskier loan. Lenders want borrowers who have skin in the game – they put their own money into the investment. This makes you more likely to make your payments. A person that borrows 95% of the value of the home is much riskier than a borrower that borrows 80%. The more you put down, generally, the lower your mortgage rate, so start saving as much as you can. This way you have more money to put down on your home. This may result in a lower mortgage rate.
The last two factors have to do with the loan itself. The type of loan and the term you take affects your interest rate. Here’s a general rule of thumb:
- The longer you borrow the money, the higher your interest rate. This is why 30-year loans have higher rates than 15-year loans, in most cases.
The type of loan also matters, though. A fixed rate loan often has a higher interest rate than an adjustable rate loan. This is only for the first few years, though. ARMs often have a ‘teaser rate’ or introductory rate. This rate lasts for a few years, depending on the term you choose. After that time, the rate can adjust, usually once per year. It usually adjusts higher than any fixed rate mortgage rate available.
Where you Live Affects Your Mortgage Rate
Keep in mind, interest rates are different throughout the country. Each state has their own ‘normal’ for interest rates. You may find very different rates from state to state. You may even find different rates within the same state. It depends on the home’s location. For example, rural areas often have different rates than suburban areas.
Finding the right interest rate is a challenge. Be ready to put the work in so you can find the lowest rate available. While you don’t have any say in how the economy runs, you can watch the market to see what it does. When rates drop, you should be ready to apply for your mortgage assuming you got the factors you can control in line.
No matter how attractive you make your loan profile, though, you must shop around. Every lender has different thresholds for risk. Even in a low-interest rate environment, you will find different rates from lender to lender. Shop around with a few lenders to see what is available to you. Compare the rates as well as the closing fees. This way you know exactly what the loan costs you today and over the life of the term. Focus on the APR and not just the quoted interest rate. This way you get the best deal over the life of the loan. Remember, this is one of the largest investments of your life. Take your time and find the deal that is right for you.