How Are Mortgage Charges Decided? Why Everybody Will get Totally different Charges
- Mortgage rates are determined by a mixture of factors that you cannot control and those that you can control.
- The stronger the US economy, the higher mortgage rates across the board.
- Lenders will offer you a lower interest rate if you have good credit or a large down payment.
- See Insider Tips For The Best Mortgage Lenders »
Several factors affect the interest rate you pay on a mortgage. Some are out of your control and while you cannot change them, you can understand them so you are ready to pay either a high or a low interest rate.
Other factors are within your control and steps you can take to get the lowest mortgage rate.
1. The economy
Mortgage rates tend to be higher when the economy is in a good condition and lower when it is in a bad condition. For example, interest rates plummeted in 2020 in response to COVID-19 because the pandemic hurt the U.S. economy.
The two main economic factors that affect mortgage rates are employment and inflation. When employment and inflation rise, mortgage rates tend to rise.
However, employment and inflation must be strong for months for mortgage rates to skyrocket. For example, inflation skyrocketed in April 2021, but rates did not respond as it was a temporary increase.
2. Federal Funds Rate
The federal funds rate is the interest rate that banks charge when they borrow money from one another, and it is taken from them
. The Fed’s rate affects the rates on credit cards, loans, savings accounts, and mortgages.
The federal funds rate does not affect mortgage rates as much as a car loan or a CD rate, for example. But the federal funds rate does have some impact and can show how the economy is doing as a whole – the higher the rate, the better the economy is doing. So, by keeping an eye on Fed interest rates, you can get an idea of where mortgage rates are headed.
Right now, federal funds interest rates are at an all-time low – as are mortgage rates.
Your credit score is a number that indicates how risky you are as a borrower. A higher credit score indicates that you are likely to pay back a loan because you paid bills on time and have borrowed (and paid back) money in the past.
The credit points range from 300 to 850. This is how the points are distributed according to the FICO model:
- Poor: 300-579
- Fair: 580-669
- Well: 670-739
- Very good: 740-799
- Excellent: 800-850
There probably won’t be much (or no) difference in your rate if, for example, you increase your score from 710 to 720. But a lender will likely give you a better interest rate if your score goes from fair to good or good to very good.
2. Debt-To-Income Ratio
Your debt-to-income ratio is the amount you pay in debt each month divided by your gross monthly income. You are about to take on more debt by taking out a mortgage and if that results in a large amount of debt that will be difficult for you to make payments, the lender will consider you a riskier borrower and charge a higher interest rate.
The lower your DTI ratio, the better. The minimum DTI ratio depends on the lender and the type of mortgage you are getting, but is usually between 36% and 50%. If your ratio is even lower than the lender’s minimum, you could get a better interest rate.
3. Down payment amount
The minimum down payment required depends on the type of mortgage you are receiving. It ranges from 0% for a VA or USDA mortgage to 20% or more for a jumbo mortgage.
If you can afford more than the minimum, the lender will likely reward you with a better interest rate.
For example, a lender’s minimum down payment for a compliant mortgage might be 3%. Your rate will likely go down if you have 10% less and even more if you have 20% less.
4. Type of mortgage
Your interest rate depends on what type of mortgage you are getting. What you can expect:
- Compliant Mortgage: This is what you are likely to refer to as a “regular mortgage”. Compliant mortgages are currently low overall.
- Jumbo Mortgage: A jumbo mortgage is available when you need to borrow a large amount of money, or at least $ 548,250 in most parts of the United States. Jumbo mortgages usually have higher interest rates than compliant mortgages.
- Government Supported Mortgages: Home loans through the FHA, VA, and USDA have the lowest interest rates for those who qualify. These mortgages are secured by federal agencies who will reimburse your lender if you default on payments. Government-secured mortgages are the least risky for lenders and therefore have the lowest interest rates.
5. Mortgage term
The shorter your mortgage term, the lower your interest rate should be. For example, a 15 year compliant mortgage has a lower interest rate than a 30 year compliant mortgage.
Remember that shorter terms lead to higher monthly payments because you are paying off the same loan amount in a shorter time frame. But you pay a lower price and save money in the long run.
Work on factors that you can control
You cannot control whether the economy is struggling or thriving. Not all of the factors that you can technically control are within your reach. For example, you may not be willing to get a shorter mortgage term with a lower interest rate because the resulting monthly payments would be too high for your budget.
But maybe you can pay off some credit card debt. This would both lower your debt-to-income ratio and likely increase your credit score, which would help you get a lower interest rate.
Look for lenders
Each mortgage lender will charge you a different mortgage rate so comparing lenders will help you get the best deal.
You can apply for prequalification from multiple lenders to compare rates. When you apply for a prequalification, a lender will review your finances and give you a general idea of what you will be paying.
You can also apply for pre-approval from lenders if you know you are about to buy. This is a more formal process that requires a hard loan application, but it does show you the exact interest rate a lender will charge. It will also lock your rate, usually for 60 to 90 days.
Mortgage and refinance rates by state
Check the current prices in your state at the links below.
About the author
Laura Grace Tarpley is an editor at Personal Finance Insider, specializing in mortgages, refinancing and lending. She is also a certified trainer for personal finance (CEPF). In her five years studying personal finance, she has written extensively on ways to manage credit.