If you’re applying for a mortgage, you’ll want to find one that offers the lowest interest rate and the best terms. As you go through the process, it can be helpful to know some of the things that affect the interest rate you will be charged.
Here are five factors that could determine the interest rate you’ll pay to borrow on a house.
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1. Economic conditions
There are many external factors that affect national average mortgage rates, which in turn affect the rate you are charged.
They include the yield on 10-year Treasury bonds, as mortgage rates tend to follow these rates fairly closely in most cases. This happens because mortgages are often touted as investment products, and investors who buy mortgage-backed securities are generally interested in these bonds as an alternative. The monetary policy of the US Federal Reserve (the country’s central bank) also affects rates, as does the supply of and demand for mortgages.
You cannot control these external factors. But you can keep an eye on national mortgage rates to try to be strategic about when to apply for a home loan. Waiting for rates to hit bottom doesn’t always work as it can be difficult to predict when that will happen. But you probably want to avoid getting a loan when rates are near record highs.
2. Your credit rating
Your personal financial information also has a big impact on the rate you’ll pay – and your credit score is one of the most important factors.
If you have a credit score of around 720 or higher, you should have access to a mortgage from almost any lender at a competitive rate. But if your score is between 500 and 600, you might want to consider government guaranteed loans as they may be the only affordable options. Government guaranteed loans, like FHA loans, are guaranteed by a government agency such as the Federal Housing Administration. This guarantee reduces the risk for lenders because if you cannot pay your mortgage, the agency that guaranteed the loan will reimburse the lender (although you may incur financial consequences). This makes it easier to qualify for a government guaranteed loan.
3. The duration of your loan
The length of your loan also affects your rate. Loans with shorter repayment terms tend to have lower interest rates than those with longer ones.
This is because there is less risk for the lenders with a short term loan. Rates are less likely to increase dramatically during a short payment period. And there is little chance that something will happen that will interrupt your ability to repay your loan.
You will also increase the equity in your home with a loan with a shorter repayment period. (Equity is the difference between the value of your home and what you owe on your mortgage. It’s basically the part of the value of your home that you actually own.) This further reduces your risk. lender since you will have more money at stake. And your loan balance is less likely to be more than the price you could sell your home at.
4. Your deposit
The more money you deposit, the less risky a loan is for a lender. Again, the risk is reduced because you have more skin in the game – and because the lender is less likely to be unable to sell the house enough to pay off the remaining loan balance.
Since a larger down payment means less risk for a lender, borrowers who put in more money are often charged a lower interest rate compared to those who have small down payments. With a larger down payment, you can also have a greater choice of lenders – and the more lenders you can compare, the more likely you are to get a lower rate.
5. Other debts you have
If you already have a lot of debt, lenders will think that giving you a mortgage is riskier. As a result, your interest rate may be higher.
The good news is that there are steps you can take to reduce your debt over time. And if you are unhappy with some of these other factors, such as your savings on your down payment or your credit score, you can work to improve them before you apply for a loan.
The more steps you take to improve your credentials as a borrower, the lower your interest rate – and total borrowing costs – should ultimately be.