What Will Your Mortgage Interest Rate Be?
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The average interest rate on a 30-year fixed-rate mortgage sits at around 4.5% across the country, according to Freddie Mac, up by almost half a percentage point from last year. However, the rates are still significantly lower than rates in October 2006, when mortgage loans had an average of almost 6.5%.
Rates fluctuate daily, and you have no control over the market. However, there are a few other things that will help determine the type of interest rate you’ll pay on a mortgage.
Factors that influence your mortgage rate
One of the first things a lender will look at when you apply for a mortgage is your credit score. Your credit score is a number that gives lenders an idea of how risky it is to extend you a loan, based on your past history of using credit.
Borrowers with higher credit scores are more likely to qualify for lower interest rates. If you have a lot of debt or past delinquencies or bankruptcies, your credit score could be jeopardizing your chances for a better rate. One of the most important things you can do is check your credit score and your credit reports. Dispute any errors you find, and pay off as much debt as possible to increase your score.
Marc Johnson, vice president of lending with Guaranteed Rate, said that one of the most important things potential buyers can do is curb their spending before and during the loan application process. “Do not apply for any credit card loans, buy a car or open new lines of credit. It can adversely affect you,” he said.
Having a low credit score doesn’t mean you’ll never be able to get a mortgage loan, but you may have to pay a higher interest rate. You could also look into FHA loans, which offer mortgage loans with a lower down payment and less stringent credit requirements than conventional loans (a conventional loan is one not backed by a government agency, like the FHA, VA or USDA). FHA rates may be similar to a conventional loan, though you’ll have to pay for private mortgage insurance on FHA loans for at least part of the loan term, if not the entire term, even if you put down more than 20% of the home’s purchase price.
It’s all about the neighborhood
Home prices and interest rates can vary based on the state, city or even neighborhood your new home is in. The rates can be different based on where your home or the lender’s office is based. Some reasons rates may be different include local foreclosure rates and laws, population (housing demand), and the cost of doing business.
Lenders in cities with higher foreclosure rates may have higher interest rates or more stringent qualifying standards to offset their risk, and some state laws dictate what a lender can charge.
Lenders with primarily rural customers may offer lower interest rates to compete with some of the bigger lenders. The lower interest rates serve as an incentive for potential buyers. The same is true for lenders in areas with huge populations and a lot of lending competition.
Home prices can also affect lending rates. Many homebuyers will use a conventional conforming loan, that is, a loan that meets the standards set by Fannie Mae and Freddie Mac. One of the most notable requirements of a conforming loan is that it falls within a certain dollar amount.
The current limit for conforming home loans is $484,350. In high-cost areas, the limit is $726,525.
If the home you purchase falls above the cap amount for a conforming loan, you’ll have to take a jumbo loan. It may have a slightly higher interest rate, though occasionally jumbo rates may be lower — and you may find it surprising that the opposite is true, too. Mortgage loans that are too small (less than $50,000) may also come with a higher interest rate. This is specifically true if the loan is used to purchase a fixer-upper. Small loans aren’t as profitable for a lender, so they may charge a higher interest rate to make more money.
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Length of the mortgage term
Mortgage loans come with various time terms. If you take out a 15-year loan, your interest rate will be lower than if you were to take out a 30-year loan. While you’ll have higher monthly payments, you could save thousands of dollars opting for the shorter-term loan and its lower interest rate. As of early January, the average rate for a 15-year fixed-rate mortgage was 3.99%, more than a half-percent less than the 4.51% for a 30-year loan.
The larger the down payment you bring to the table, the better the rate you’ll likely qualify for, because lenders view your down payment as a sign that there’s less risk to lend you money.
Other benefits of having a large down payment may include eliminating the need for mortgage insurance, which means a lower mortgage payment.
Any type of mortgage loan you take out will either be a fixed-rate loan or an adjustable-rate mortgage (ARM). A fixed-rate loan means your interest rate (and monthly payment) will stay the same for the entire length of your loan. With an ARM, a lender will adjust the rate on based on the terms you’ve agreed to. For example, a 5/5 ARM is a 30-year mortgage during which the rate is fixed for the first five years of the loan. After that, the rate can go up or down every 5 years — it depends on where rates are at when the adjustment occurs. Typically, interest rates on ARM mortgages are lower, at least initially: the rate can go up or down depending on the market.
Another factor that could affect your interest rate is the type of mortgage you take out. There are a few different types of loans. We’ve already talked about the difference between a conforming and jumbo loan. Other types of loans FHA loans, VA loans, and USDA loans.
FHA loan: FHA loans are available to any buyer. But, they are often favored by first-time buyers who don’t have large down payments or have less-than-stellar credit. FHA loans allow for down payments as low as 3.5%, and consumers with lower credit scores may still qualify for a mortgage loan this way.
USDA loan: The USDA provides loans for buyers who are willing to purchase property in rural areas. The purpose is to help keep farming lands populated, and to strengthen the farming industry. These loans have strict requirements, including location and income. Borrowers can obtain these loans without private mortgage insurance, even if they don’t have 20% down payment. Interest rates on rural loans can be significantly lower than other loan types.
VA loan: Active-duty service members, retired veterans and some surviving spouses can qualify for home financing through a VA loan. While these loans have the same loan limits as conforming loans, borrowers who qualify can get a loan with a very low (or no) down payment. Unlike other loans, there is no private mortgage insurance requirement. Rates on these loans may be lower than conventional loans.
The bottom line
Lenders look at a lot of factors when they determine what interest rate to offer. Friends and family who live in different parts of the country, or even down the block, could have a different number attached to their loan based on many different things. The best things you can do are speaking to lenders about what you can do to improve your chances of qualifying for a good rate and comparison shopping to ensure you go with your best option. You can start the process here by filling out a form on LendingTree and comparing potential loan offers.