What
Determines Your Interest Rate?
What Determines Your Interest Rate?
Let’s start with a few questions.
- You will see super low mortgage rates advertised in the market. Can
you get one of those rates? -- Probably not! In many situations, your
rates might be marked up and you might have to pay much higher price.
- Is the interest rate the most important part of your mortgage loan?
-- It depends!. There are situations when a higher interest rate and
lower closing costs might be the best deal.
Mortgage interest rate is one of the key issues to consider when you
are looking for a mortgage loan because just a point drop or rise makes
a huge difference in the amount of money you repay. From the lender’s
perspectives, adjusting interest rates is a way to compensate any risk
lenders might take to originate a loan. If you are considered as a higher
risk borrower, you will get a higher interest rate. You can almost always
get a loan, but if you want something out of the ordinary, it'll cost
you.
The following factors can affect your interest rate. If you have a better
understanding of these factors, you will be able to be better prepared
and make a better choice in finding the right mortgage for you. Remember,
it is always good to ask your lender if there is anything you can do to
reduce the rate.
Your Credit
If you have credit problems, you have a very good chance of paying higher
interest. When you apply for a mortgage, lenders will typically determine
your credit grade by looking at your credit profile, credit score and
other factors. This credit grade is often used in determining the interest
rate that you are eligible for. The lower credit grade you get, the higher
interest you will be quoted.
Prim Mortgage vs. Subprime Mortgage
If you get a grade of A, generally given to a borrower with a credit
score of at least 620 and no late mortgage payments in the past two
years, your are considered as a prime borrower and the lender will quote
you its best rate and terms. If you have bad credit, considered as subprime,
you can still get a loan, but the terms and interest rate won’t
be that good.
This is why it is so important to maintain your credit well in advance
before you look for a mortgage. Check your credit report first. If you
have problems with your credit, assess the problem areas, and start to
fix them right away.
More Info:
Down Payment (Loan to Value Ratio)
A larger down payment – greater than 20% - will give you the best
possible rate. Down payments of 5% or less should expect to pay a higher
rate as you are starting with less equity as collateral. Besides, you
have to make sure that the down payment is your own money set aside as
savings, not borrowed specifically to make the home purchase.
Types of Loan Program
Depending on the type of loan program you choose, you will be given
a different interest rate.
- Conforming vs. Jumbo Loan: The interest rate goes up if the amount
financed exceeds the conforming loan limits established by Fannie Mae
and Freddie Mac.
- Length of Loan: Shorter loans will reduce the rate.
- Fixed vs. Adjustable Rate: An adjustable rate mortgage may get you
started with a lower initial interest rate than a fixed rate mortgage.
Discount Points
An interest rate quote is completely meaningless, if not quoted with
the points on the loan. A point is a fee for borrowing money equal to
1 percent of the amount you borrow and is paid at the time of the closing
of the home. The more points you pay, generally the lower your interest
rate. If you have extra cash and you think you’ll be in the home
for a relatively long period of time, you may be better off paying points
on your loan to lower your mortgage rate. However, if you don't anticipate
keeping the house for a long time or if you are not sure about your future,
paying additional points may not make much sense.
More info: Should
you pay the Points?
How Much Information You Provide
There might be situations you don’t want to share information
about your income, assets or employment. Depending on how much documentation
you are willing to provide, you can end up paying anywhere from one-quarter
to two and a half percentage points more in rate.
No-doc/low-doc mortgage: Many self-employed people
have problems with preparing valid documents for mortgage application,
because they have to document income and employment through personal
and business tax returns. They can apply for a “no-doc (documentation)”
or “low doc” mortgage, a mortgage in which the underwriter
decides on the loan based on limited information such as the applicant's
credit history, the appraised value of the house and size of down payment.
In this case, the interest rate will be marked up depending on how much
documentation they are willing to provide.
Purpose of the Loan
If you get a loan to purchase a certain type of property or for a certain
purpose, it could mark up your interest rate. Customers buying some condominiums,
second homes and houses they plan to rent out generally have to pay higher
interest, as do consumers who want to cash out a lot of their equity by
refinancing.
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