Review of all things Real Estate: What factors influence mortgage interest rates?

When searching for a loan, most borrowers will seek the one that offers the lowest mortgage interest rate. A low interest rate means less expensive monthly payments, so the borrower will be saving money over the life of the loan. Below are the common factors that influence mortgage interest rates.

1. Credit score

One of the largest contributors to a mortgage rate is the borrower’s credit score report. A credit score is a summary of your borrowing history, including any late payments, inquiries, credit cards and/ or loans. The purpose of a credit score is to give a lender an idea of how risky a particular borrower is; the higher the credit score, the less risky the borrower.

Generally, a borrower with a high credit score will be rewarded with a lower interest rate by a lender. Before applying for a mortgage however, you should view your credit report which can be obtained for free every 12 months from credit bureaus. Once you’ve received your credit report, make sure it is accurate. If you come across incorrect reports on your history, dispute those with the credit bureaus to ensure your report is accurate when your lender reviews it.

2. Location

Interest rates can vary depending upon the location of the property you are looking to purchase. There are several reasons location can influence the interest rate you may qualify for; one is because states have different foreclosure laws. Other borrowers in the area can also impact the interest rate because lenders take into consideration the homeowner default rate in the geographical area.

3. Property type

Condo interest rates generally are higher than single family residences because condos have higher foreclosure rates than SFRs. A second home or investment property will require a larger down payment and generally require higher credit scores because investment properties and second homes have higher foreclosure rates than owner occupied properties.

4. Occupancy

An owner occupied property will have lower interest rate than a second home or investment property. An investment property rate can be as much as one percent higher depending on the credit score and down payment. This can be mitigated by a larger down payment which reduces the risk to the lending institution.

5. Down payment

The higher the down payment provided, the lower the interest rate. A lender views a borrower as a lower risk if they’re putting more toward the home upfront which will decrease the amount of funds that will be borrowed. If the borrower is putting down less money toward a property, this is considered higher risk and is less favorable in the eyes of a lender.

Those providing a 20% down payment on a home should qualify for a lower interest rate than a borrower who is only providing 5% down. If you put down less than 20%, you will be required to pay Private Mortgage Insurance which will also increase your overall payment.

6. Current interest rates in the market

The Federal Reserve doesn’t set mortgage interest rates, but they set federal fund rates which are the rates which financial institutions charge to lend funds to each other. The higher the federal fund rate, the more costly it will be for the institution to borrow funds causing an increase in interest rates on products such as HELOCs, auto loans and credit card debt. Federal fund rates have an indirect impact on mortgage interest rates as a function of the bond market. More discussion on this complex relationship will be in future articles.

7. Length of mortgage

Shorter term mortgages are accompanied by lower interest rates because lenders view borrowers who need a long term loan as riskier than those who need a shorter term. If a borrower chooses a 30 year loan, this allows more time for the borrower to potentially default on the loan whereas a 10 year or 15 year loan would be considered lower risk.

8. Type of loan

Common types of mortgages include Conventional, Jumbo, VA, FHA, and USDA loans, and interest rates vary among these types of loans due to different qualification requirements. Most jumbo loans will require at least a 10% down payment while conventional loans allow as little as 3% down. Loans like VA, FHA, and USDA are government-insured loans which often have lesser interest rates because they are government insured.

The bottom line

There are many variables that determine mortgage interest rates and understanding the factors can help you choose the best mortgage product for your circumstances. As your mortgage interest rate could be influenced by a combination of these factors the best way to determine what your rate will be is to consult with one of our local expert loan officers.