If you’re considering buying a home, you’ll want to pay attention to more than just the purchase price. You’ll also want to familiarize yourself with mortgage interest rates. These rates increase the total cost of your home, and even the smallest difference in your rate can have a huge impact on how much you’ll pay over the life of the loan.
- Mortgage rate basics
- Compare mortgage rates
- How your mortgage rate is determined
- How to get a mortgage
- FAQ
Mortgage interest rate basics
Mortgage interest rates play a key role in determining how much a home purchase will actually cost. They amount to a fee you pay to your lender in exchange for being able to borrow money from them.
Mortgage rates are broken out into two categories:
- Fixed: Fixed mortgage rates stay the same over the life of the loan and are often favored for their stability.
- Adjustable: Adjustable mortgage rates typically start out low and then grow after an initial period. These rates can go up and down depending on market conditions but can be helpful for borrowers who are worried about affording initial interest payments.
How to compare mortgage rates
Comparing mortgage rates is crucial, whether it’s your first home purchase or your fifth. Doing so gives you the chance to get the best interest rate possible, which could save you thousands of dollars in the long run. To compare rates and make sure you get the best one, consider the following steps:
Get personalized rate quotes
Online rate comparison tools have changed the game when it comes to getting rate quotes. By inputting basic information about you and the property you wish to buy, you can get rate quotes from multiple lenders in a matter of minutes. From there, you’ll have the chance to compare not only your personalized rate estimate but also the terms and fees associated with the loan.
Note that the most current mortgage rates change daily, so check today’s average mortgage rates before you start shopping around.
Consider all the costs
When choosing a rate, you’ll want to consider all the costs, including fees and discounts offered by different lenders. Before settling on a rate, take these into account and calculate the total cost of the loan. You may be surprised to find that a higher interest rate could actually be cheaper than a lower one when all of these costs are factored in.
Evaluate long-term affordability
Before deciding on a lender with a rate that works for your current finances, consider whether or not you can afford the loan in the long term. Depending on your personal and financial goals, you may find that a mortgage rate, however low, just isn’t affordable for you.
Consider different loan terms
Although many people choose to get a 30-year mortgage term, lenders often offer 15-year mortgage terms as well. This 15-year loan term can save you big when compared to a 30-year term since shorter terms often come with lower interest rates. You can see this in action when looking at today’s current fixed mortgage rates:
- 30-year: 7.04%
- 15-year: 6.38%
Let’s look at an example of how loan terms affect mortgage rates using a $250,000 loan with a 3% interest rate (to keep it simple, we’ll use this interest rate for both the 30- and 15-year mortgage). This will cost you $129,444 in interest alone over the life of a 30-year loan. If you adjust the data to reflect a 15-year term, you’ll pay $60,762 in interest.
One caveat: While the interest rate will be significantly smaller on a shorter loan term, the monthly payments will be higher. For a 30-year term, you would owe $1,054 a month, while a 15-year term will be nearly $700 more expensive, clocking in at $1,726 a month.
How your mortgage rate is determined
Your mortgage rate is determined by several different factors; some you can control, and others you can’t.
“It’s important to understand these factors and work to improve them before applying for a mortgage. By doing so, you can potentially qualify for a lower mortgage rate and save thousands of dollars over the life of your loan,” advised Erica Davis, a branch manager at Guild Mortgage.
To determine your rate, mortgage lenders pay attention to:
- Credit history: Lenders look at your credit score and report to determine your credit outlook. If you have less favorable credit with a history of missed payments, you’ll likely have a higher interest rate than those with good credit.
- Down payment: A larger down payment can demonstrate to lenders that you’re a low-risk borrower, scoring you better terms on the loan. Borrowers that offer a higher down payment also typically have a lower loan-to-value (LTV) ratio, which compares the loan amount to the appraised value of the property. A lower LTV ratio indicates a lower risk for lenders, leading to more favorable mortgage interest rates for you.
- Discount points: You have the option to pay discount points, which are due at closing, to help lower your interest rate. By covering the cost of these points upfront, you not only get a lower interest rate but also a lower monthly payment.
- Loan term: The amount of time that you need to pay back your mortgage has an impact on your rate. Typically, the shorter the loan term you need, the less risky lenders consider you, and the lower your interest rate.
- The economy: The overall state of the economy plays an impactful role in determining your mortgage rate. For example, during times of high inflation (like right now), interest rates rise for borrowers. This is because inflation erodes the purchasing power of money. So, when lenders give out mortgages, they’re expecting to receive interest payments over a long period, typically 30 years. However, if inflation is high, the value of those future interest payments decreases. To compensate for this, lenders hike up interest rates.
- Type of loan: The type of mortgage that you’re taking out can determine your interest rate. For example, FHA loans often come with lower interest rates (assuming you have good credit) because the government backs part of the loan, making it less risky for the lender.
- Market competition: There are dozens and dozens of mortgage lenders out there, all competing for the attention of potential borrowers. To win you over, some lenders try to outdo their competitors’ interest rates and offer you a better deal.
How to get a mortgage
To get a mortgage, you’ll need to follow several key steps:
- Determine if you’re eligible: You’ll want to assess factors like your finances, credit score, income, and debt-to-income ratio (DTI) to determine whether or not you can qualify for a mortgage. To make this process simpler, you may want to work with a housing counselor who can advise you on home buying.
- Gather necessary documentation: Since it can take time, you’ll want to start gathering and organizing documents as early as possible. You should gather documents like your pay stubs, tax returns, identification, bank statements, and proof of employment.
- Shop around for the best lender: By researching and comparing many mortgage lenders before settling on one, you can find the best rate and terms. Online rate estimate tools make this an easy process.
- Fill out a mortgage application: Once you’ve decided on a lender, you should complete its mortgage application. This will involve providing accurate information about yourself, your finances, your employment, and, potentially, the property you want to purchase.
- Go through underwriting and approval: After submitting your application, your lender will do a thorough investigation to determine the accuracy of the information you provided and your ability to pay back the loan. If the underwriter is satisfied, your loan will be approved.
- Close on your mortgage: At closing, you and the seller will complete the transaction of purchasing your home. During this process, you’ll sign the paperwork, pay closing costs, and become legally responsible for paying the mortgage.
FAQ
Will interest rates go down in 2023?
It is difficult to predict whether or not interest rates will go down in 2023. To find out when and if they do, you should stay up to date with economic indicators, like market conditions, and consult with a mortgage expert.
What’s a good mortgage rate?
Generally, a mortgage rate is considered good if it is below the market average. That said, a good rate for your financial situation won’t necessarily be a good rate for others. You should aim to find the best rate by comparing quotes from multiple lenders and monitoring average rates.
What is a rate lock?
A rate lock is when a borrower and a lender come to an agreement that guarantees an interest rate for a set period of time. If the interest rate goes up during the time it takes to apply for and close on the loan, the rate will be the same as it was when the agreement was made. Typically, rate locks last between 30, 45, and 60 days, but this can vary between lenders.
What is private mortgage insurance?
Private mortgage insurance (PMI) is a type of insurance that helps protect lenders in case a borrower defaults on their loan. If you make a down payment on a conventional loan of under 20% of the home’s cost, you’ll be required to pay for PMI until you’re scheduled to have paid off 80% of the original value of your home.