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5 Factors That Determine Mortgage Interest Rates

For most people, a home is the biggest purchase of their lives. And with prices starting in the hundreds of thousands of dollars, fractional differences in interest rates can have a huge effect on how much home you can afford. As you shop around for quotes, it’s important to understand how these five key factors affect mortgage interest rates.

1. Credit Score

Lenders use your credit score to decide how much risk they’d be taking on if they lend you money. Specifically, they’re trying to assess two things: your ability to pay in the future and your history of paying past loans. Your ability to pay back a loan is assessed from your income, your obligations, and your likelihood of taking on more debt. Your history tells lenders whether you have a record of paying what you owe on time. The higher your credit score, the lower the interest rates you’ll likely see. You can still borrow with a lower score, but the lender may charge more to cover the perceived risk.

2. Down Payment

In general, the larger the investment you’re making in the property you’re buying, the lower the interest rate you’ll get on the mortgage you need to cover the rest. When you have more skin in the game, lenders see you as a lesser risk. If you can put 20% down, you will likely get a better interest rates, and relief from mortgage insurance premiums.

3. Loan Term

Think of loan interest as paying for the amount of time you borrow money. If you keep the money for a shorter time, you’ll not only pay less total interest, but you’ll likely see lower interest rates on the loan itself. Play with different combinations of loan terms and interest rates and see which one works out the best for you.

4. Interest Rate Type

Loans typically have either fixed or adjustable interest rates. With a fixed rate loan, you pay the same rate for the life of the loan. Interest rates for these loans are usually higher because the lender is tying up money it won’t be able to lend elsewhere if interest rates go up in the market at large. With adjustable rate mortgages, on the other hand, the lender can offer lower interest rates in the first years of the loan. At the end of the initial period, the rate will be pegged to the market, so the lender will earn market rates on that money in the years ahead.

5. Market Factors

Mortgage loans are just one product in the financial market, and mortgage interest rates rise and fall in response to inputs from countless unrelated variables that together establish the global economic temperature. Natural disasters, the cost of fuel, strength of currency, housing market conditions, monetary policy actions, national economic growth, status of the stock and bond markets—all these things (and more) come together to affect mortgage interest rates. In general, mortgage rates rise and fall roughly parallel with the interest rates set by the Federal Reserve. But they can tick up or down independently, depending on local or housing-specific conditions.

As you shop and compare mortgage interest rates, ask the questions you need to determine what’s behind the differences. A good lender will help you identify the mortgage you can live with happily for as long as you’re in your home.

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