Introduction
When it comes to mortgage loans, think of interest rates as the celebrities, because they’re the ones that grab all the headlines!
The real story is that many factors influence both the amount of your mortgage and your monthly payment, including the price of the home, the amount you’re borrowing, your down payment, and, yes, interest rates. But don’t count interest rates out as a factor beyond your control! You might have more of a hand in determining yours than you think.
What are interest rates?
When you borrow $20 from a friend, you typically pay them back the exact same amount – $20. Because mortgage loans are so much larger, lenders charge an interest rate for borrowing the money to buy a home.
Commonly calculated as a percentage of the loan amount, a portion of the interest rate is then paid back each month as part of your mortgage payment. This means your monthly mortgage payment is actually the sum of two payments – one toward the principal of the loan (the amount you borrowed) and one toward the interest on the loan (the cost of borrowing).
Why are interest rates important?
Most people want to get the lowest interest rate possible, because your interest rate ultimately influences the amount of your monthly payment as well as the total amount you pay over the life of the loan.
Your monthly principal is calculated from the amount you borrowed divided by the term of the loan (typically 30 years, or 360 months). The amount you owe in interest is also divided into monthly payments over the life of the loan, so if your interest rate is lower, not only will your monthly payments be lower (remember: principal + interest = monthly payment) but the total amount you’ve paid over the course of the loan ultimately will be much lower as well (monthly payment X length of loan = total amount you pay).
Your loan officer will be able to figure out exactly how much you can afford to spend on a home.
How are interest rates calculated?
When the Federal Reserve moves interest rates, it’s big news, but it’s important to remember that mortgage rates are ultimately calculated based on several factors:
- Government policy (this is where the Federal Reserve comes into play)
- Your individual credit history (something you can play a part in!)
- The type of mortgage loan (some government-backed loans like FHA come with lower interest rates)
- The size of your down payment (another factor you can control!)
- The term of the loan (a 15-year would ultimately include less interest than a 30-year loan)
Over the past 50 years, mortgage rates have averaged around 8%. Because it’s not easy to predict when mortgage rates might rise or fall, people generally answer that the best time to lock in a mortgage rate is now!
What can I do to get the most favorable interest rate?
Looking at the list above of factors that dictate interest rates, try to remember that there are quite a few that are within your power to control! Some of them, depending on your financial situation, might be harder to influence, such as the amount of down payment you can afford as well as the length and type of your loan, but a qualified loan officer can help you figure out which of these factors might be within your grasp to tweak.
The single biggest factor you control in setting your interest rate is your credit history. A mortgage lender looks at your credit history from a broader scope than a credit card or car company might. Debt-to-income ratio checks in as a big element, meaning the total amount of your debt compared to the amount you earn in income. Other elements include your total debt, the length of your credit history, your payment history (specifically late or unpaid payments) and the amount of available credit you have.
Simply put, a higher credit score can net you a lower interest rate, translating to lower monthly payments and lower total costs over the lifetime of the loan.
Want a better idea of what your interest rate might be?
Contact Keller Home Loans to speak with a dedicated loan officer who can help you explore your options and find out more about mortgage rates.
