Every home buyer and homeowner wants to get the lowest possible mortgage rate when taking out a loan. But how do you actually achieve this goal? What are the primary factors that affect the mortgage rate you receive from a lender?
There are quite a few variables, but some “weigh” more than others. In this article, we’ll examine six of the main factors that influence your mortgage rate.
Six Factors That Determine Your Mortgage Rate
Of all the different factors that can influence a borrower’s interest rate, there are six that rise to the top of the list. They include the following:
1. The type of property you’re buying
Borrowers can receive different mortgage rates for different types of properties. That’s because different types of properties (e.g., single-family detached, duplex, condo, etc.) have different levels of risk associated with them. A detached Single Family home will have the best rates and costs associated with it. Multi-family homes and manufactured homes will generally have higher rates.
Statistically speaking, each of these property types has a different likelihood of default based on historical trends. So the type of property you are buying can also affect the mortgage rate you receive. Condominiums are sometimes considered to be a “riskier” purchase than a regular single-family detached home. So currently higher rates may apply to a condo when putting less than 25% down on conventional financing.
2. Occupancy (second home vs. primary residence)
Are you buying a home to serve as your primary residence? Or will it be a second home to serve as a vacation or investment property? This distinction can affect your mortgage rate.
Banks and lenders charge higher rates for a rental/investment property than they charge for a primary residence. Generally speaking, there’s a higher level of risk associated with investment properties compared to a primary residence. For a conforming loan backed by Fannie Mae or Freddie Mac there is no rate adjustment for a second home/vacation property when compared to a primary residence; however, on many Jumbo loans second homes have higher rates and higher down payment requirements.
3. Size of your down payment
How much do you plan put down when buying a house? This is another factor that can affect your mortgage rate. A higher down payment results in a lower loan-to-value (LTV) ratio, and therefore a lower level of risk for the bank or lender making the loan. You can probably see the pattern developing here — more risk tends to equal higher rates, and vice versa. When putting 20% or more down you are able to avoid Private Mortgage Insurance (PMI), but did you know that putting more than 20% down can further improve the terms of your loan? When purchasing a home with a conforming loan your terms improve when you put 25% or 40% down. Putting more down can also help minimize the negative impact of a lower credit score.
4. The borrower’s credit score
Your credit score is a three-digit number based on information compiled within your credit reports. You actually have three primary credit reports (from Equifax, TransUnion and Experian), so you have three scores as well. Lenders will use the middle FICO score between the three bureaus when determining the pricing of a mortgage. If there are multiple borrowers on the loan a lender will use the lowest middle FICO score of any borrower on the loan.
For a conforming loan a 740+ credit score is needed in order to get the best rates and costs available while FHA and VA loans have lower thresholds to get the best rates. Many Jumbo Loan programs have additional price improvements when scores exceed 760-780.
People who pay their bills on time and maintain low balances on revolving debt tend to have higher scores. A higher score can help a borrower qualify for a lower mortgage rate. According to consumer credit experts, you can maintain a high score by paying all of your bills on time, and by limiting your use of credit to minimize your “credit utilization rate.”
5. Loan type and amortization
Fixed-rate loans tend to have higher rates than the initial rate on an ARM. But “initial” is the key word in that sentence. The interest rate assigned to a fixed mortgage will stay the same, while an ARM loan can fluctuate — and possibly rise — over time.
Opting for a shorter fixed rate term such as a 15 year fixed or 20 year fixed can also improve the terms of your loan and significantly reduce the interest paid over the life of your loan. Sammamish Mortgage can help you assess whether a shorter loan term is right for your specific financial situation.
6. Market rate movement
Market forces affect all of us, on a daily basis. The forces of supply and demand determine how much we pay for gas, groceries, electronics, cars, homes and — yes — mortgage loans. There are various market forces that can influence mortgage rates, and they are constantly in flux.
A strong economy and rising inflation are currently causing mortgage rates to increase. Even if you qualify for the best rates at any given time, when you get your mortgage has just as big of an impact as the factors outlined above.
Investor demand within the secondary mortgage market, economic growth, Federal Reserve policy — all of these things can have an indirect effect on mortgage rates.