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How Are Mortgage Rates Determined?

When you’re shopping for a new home, you’re likely also shopping for a new mortgage — and it’s generally in your best interest to find the lowest interest rate you can. 

The higher your interest rate, the more you’ll pay over the lifetime of the loan for the privilege of getting the money up front, which can eat into the potential profit you may earn in equity if the value of your property increases.

But how are mortgage interest rates determined in the first place, and how much control do you have over what interest rates you can qualify for? Mortgage rates are determined using a variety of factors, many of which are out of your control — but understanding the calculation can help you make a more informed purchase decision.

How the market affects mortgage interest rates

As the economy and the stock market shift, so too do mortgage rates. Banks update their rates according to the strength of the economy, the interest rates set by the Federal Reserve, the performance of the stock and bond market, the rate of inflation, the unemployment rate and other factors. 

The basic rule is, the worse the economy is doing, the better mortgage interest rates are — which sounds counterintuitive, but is actually by design. For example, the Federal Reserve (sometimes called simply The Fed) will lower their short-term interest rates specifically to stimulate the economy — and although those rates aren’t available directly to consumers, that’s the rate the banks are borrowing at, so it’s likely to affect your individual rate as well. This is particularly true for adjustable-rate mortgages, in which the monthly mortgage payment and interest amount can be reconfigured based on what the market is doing.

How loan term affects mortgage rates

This is true of most loans, and home loans are no exception: the shorter the term (repayment period) of your loan, the lower the interest rate will probably be. That means if you’re able to take out a 15-year mortgage, you’ll likely score a lower interest rate than you would on a 30-year loan. 

That said, this tactic comes with a cost. Although the interest rate might be lower, shorter-term loans also tend to have significantly higher monthly payments, so you may not be able to reasonably afford to save money in interest using this tactic.

How personal factors affect mortgage interest rates

Finally — and fortunately — some of the most important parts of the mortgage rate calculation are personal factors that you do have a lot of influence over. For example, your credit score, existing debt-to-income ratio (DTI), and down payment amount can all have a major impact on your mortgage rate.

Generally speaking, the higher your credit score and cleaner your credit history, the better; conversely, a lower credit score usually translates to a higher interest rate. Your mortgage lender is taking a risk by offering you a six-figure loan, after all, so seeing a demonstrable pattern of good behavior in your past may make them more likely to offer you lower loan rates.

Keeping your DTI low can also help you score a better mortgage rate — and indeed, keeping your DTI under certain thresholds is a prerequisite to qualify for a mortgage loan at all. Most lenders will implement a DTI cap over which borrowers are ineligible for a mortgage; this cap is usually around 41% or 43%, but 50% tends to be the absolute maximum (though as always, caps vary by the type of loan and lender you choose, so check with your agent directly). That’s why it’s a good idea to take some time to pay off your credit cards and any other outstanding debts before you start seriously considering a home purchase.

Finally, although you don’t need a large down payment to qualify for a mortgage, especially with government-backed lending programs like FHA loans, the larger your down payment is, the lower your interest rate will likely be. Additionally, you may be able to avoid taking out mortgage insurance, which can add to your total monthly payment, if you’re able to make a down payment of at least 20% of the home price. (This calculation may also be expressed the other way: if you’re able to keep your LTV, or loan-to-value ratio, 80% or lower.)

Still, the long-term savings might not make up for equity you might miss out on if you put off your purchase for months or years, even with a higher interest rate. It’s important to sit down and crunch the numbers — with professional help, if you can.

Along with our many checking and savings products, Quontic Bank is also proud to offer a range of mortgage products built for every kind of borrower, including those who may have trouble qualifying for a conventional loan. If you’re self-employed, a foreign national, or someone whose income fluctuates, we may still be able to help you find a prime mortgage at a competitive interest rate. We offer loans to first-time homebuyers as well as existing homeowners looking to refinance, borrowers looking for real estate investment properties, and more.. Contact us today for more details.

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