Navigating the world of home loans can feel like trying to solve a Rubik’s Cube blindfolded (yikes,) especially when it comes to understanding interest rates. But don’t worry, we’ll break it down together.
So what is an interest rate?
The interest rate is essentially the cost of borrowing money from a lender, expressed as a percentage of the loan amount. It’s what the lender charges you for the benefit of using their money to buy a home. But how do they decide what that rate is? Let’s dive in!
Factors influencing interest rates
Several key factors determine the interest rate you’ll receive on your mortgage:
Credit score: Your credit score is like your financial report card. A higher score usually translates to a lower interest rate because it signals to lenders that you’re a responsible borrower. If your score is on the lower side, expect to pay a higher rate. As long as your credit score is in a solid range, the affect several points higher or lower will have on your interest rate, won’t really affect your interest rate by enough to have a big change on your monthly payment.
Loan type: Different types of mortgages (e.g., conventional, FHA, VA) come with different rates. Generally, guaranteed loans like VA or FHA can offer lower rates for borrowers with strong credit and larger down payments.
Loan term: The length of the loan affects your rate. Typically, shorter terms (like 15 years) come with lower interest rates compared to longer terms (like 30 years) because the lender’s risk is reduced.
Down payment: The more you put down upfront, the lower your interest rate can be. A substantial down payment shows lenders that you have skin in the game, which can lead to better rates.
Market conditions: Interest rates fluctuate based on broader economic factors, including inflation, the economy’s health, and the Federal Reserve’s actions (or what the market thinks the Fed will do). When the economy is strong, rates may rise; during economic downturns, they might fall.
How lenders set rates
Lenders use a combination of the above factors, along with their own operating business cost, to determine interest rates, (we cut unnecessary costs here at Tomo Mortgage to be able to offer rates 0.48 points lower than the typical lender). They often refer to market benchmarks, such as the 10-year Treasury yield, which reflects the interest rates investors are willing to accept for government bonds. When this yield rises or falls, it typically influences mortgage rates.
The Fed’s role in setting rates
You might be wondering, “How does the Fed fit into all this?” Well, here’s the scoop: while the Fed does influence overall economic interest rates, it doesn’t directly change your mortgage rates. Often, mortgage rates adjust before the Fed makes a move. For example, after the Fed announced a rate cut, mortgage rates sometimes stayed steady or even increased. This is because the market had already anticipated the Fed’s decision, meaning your mortgage rate may reflect expectations rather than immediate changes.
Calculating your personalized interest rate
While you can’t calculate your exact mortgage interest rate without the lender’s input, you can get an estimate based on the following:
Base rate: Start with the current market rate for mortgages. This is influenced by the economic factors mentioned above.
Adjustments for risk: Lenders will assess your credit score, down payment, and loan type to make adjustments. For example, if your credit score is below 700, they might add a premium to the base rate.
Shop around
Interest rates can vary significantly from lender to lender. It’s wise to compare rates from multiple sources before making a decision. A small difference in interest rate can mean significant savings over the life of your loan.
Using a mortgage calculator for understanding your budget, given where rates stand
While it’s not a crystal ball for your interest rate, a mortgage calculator can help you estimate what your monthly payment might look like based on a range of potential rates. This is a great tool when you’re shopping around and trying to gauge how different rates affect your budget.
If you’re ready to start your journey to homeownership, get pre approved with Tomo Mortgage today.
