Understanding Mortgage Interest

Understanding Mortgage Interest

Interest Rate Factors

When lenders set your mortgage interest rate, they consider a wide range of factors, including your credit, loan term, home price and down payment, and whether it’s a fixed- or adjustable-rate mortgage. Knowing these factors can help you figure out how to qualify for a better rate.

The Consumer Financial Protection Bureau offers a calculator for average interest ratesbased on your credit score, state, house price, down payment and other factors.

Credit score. When you apply for a mortgage, the lender considers your credit score. Your credit score is based on your credit history and represents how safe you are as a borrower. FICO, the most commonly used credit score, ranges from 300 to 850. The higher your score, the better the chances you’ll qualify for a low interest rate.

You need a minimum credit score of 620 to qualify for a mortgage under Fannie Mae or a score of at least 500 to qualify for an FHA mortgage. If your score is between 500 and 579, you could qualify for an FHA loan, but with a down payment of at least 10 percent. If your score is higher than 580, your down payment can be as low as 3.5 percent. VA loansdo not have a minimum credit score requirement as lenders will consider your entire financial situation to make a decision. USDA loans require a minimum credit score of 640 for automated underwriting, though you may be able to qualify with a lower score if the lender manually underwrites your application.

Home price and loan amount. The more money you borrow for your loan, the higher the interest rate will likely be. Lenders are risking more money with larger mortgages, so they may charge a higher interest rate. There are maximum limits for loans. FHA loan limitsvary by area and can be as low as $275,655 and as high as $636,150, depending on the cost of living in each area of the country.

The maximum loan amount for conventional mortgages in most of the country is $424,100, though this can be higher in certain areas or for multiunit properties. If you want to buy a property that costs more than these limits, you can apply for a jumbo loan, also known as a nonconforming loan. Jumbo loans typically charge a higher interest rate because there is a higher amount at risk.

Down payment. Your down payment is the amount you pay upfront for the property, while the mortgage covers the rest. A larger down payment leads to a lower interest rate on your mortgage. You’ll be borrowing less money, so lenders are taking on less of a risk.

If your down payment is less than 20 percent of the house price, you’ll need to buy private mortgage insurance and pay the premiums as part of your mortgage payments. This insurance reimburses the lender if you default on the mortgage.

Loan term. The longer the length of your loan, the higher the interest rate may be. Rates are higher on a 30-year mortgage compared to a 15-year mortgage.

Interest Rate Type

Interest rate type refers to whether your mortgage is fixed or adjustable. At the beginning, lenders charge a higher rate on fixed-rate mortgages.

Loan type. Government-backed loans typically charge lower rates than conventional mortgages, but FHA loans can be more expensive once you factor in other fees, like mortgage insurance.

Points. Mortgage points are a fee you can pay at the start of the mortgage to lower your interest rate for the duration of your fixed-rate mortgage. Each point costs 1 percent of your total loan amount. The interest rate reduction depends on the lender, but it is common to lower your interest rate by 0.25 percent in exchange for every point purchased.

You can also purchase points to lower the initial interest rate on an adjustable-rate mortgage. On a 5/1 ARM, buying points would lower the interest rate for the first five years before the rate adjusts.

The longer you plan on staying in a property, the more it makes sense to pay points. You’ll benefit from the lower interest rate for a longer period of time.

Property type. Lenders change their interest rate depending on the type of property. Single-family homes are considered less risky and have lower rates. Multifamily properties, condos, co-ops and mobile homes are considered riskier, so mortgages for these properties often have a higher interest rate.

Property use. If you plan on using the property as your primary residence, you’ll get a lower rate because people are less likely to default on their homes. On the other hand, if you’re buying a property as an investment or a vacation home, your interest rate will be higher. People are more likely to default on these properties because they’ll still have their primary residence to live in.

Market interest rates. Lenders base their interest rates on market benchmarks such as the Libor or the weekly constant maturity yield on the one-year Treasury bill. Lenders use these rates to compare mortgages to other investment opportunities, such as bonds or lending to the government instead.

Interest variations by state. Where you plan on buying a home can have an impact on your mortgage interest rate. There’s a significant difference between states. Counties, cities and even neighborhoods can have different mortgage rates as well.

Interest rate vs. APR. Lenders are required to provide the annual percentage rate and loan interest rate. When you’re comparing different mortgages, you should consider both the interest rate and APR as you make a decision.

The interest rate is the percentage of the loan you pay for borrowing the money. The APR includes the interest rate and the upfront costs of taking out the mortgage, such as loan underwriting fees, origination fees and points. If you need mortgage insurance, those premiums should be included in the APR.

The APR spreads these expenses over the life of the loan, so you can see how much it costs per year to borrow money once you factor in these charges. A loan with a 3.5 percent interest rate might have an APR of 3.65 percent after it adds in the other expenses.

Amortization. Amortization is how a loan is paid off over time. When you take out a mortgage, the payment schedule is set up so that at the beginning, most of your payment goes to paying interest, not paying down the principal. Later on, more of your money goes to paying off the principal and less to interest.

This mix has an impact on your finances. You get a tax deduction for paying interest on a mortgage for your primary residence, but there’s no deduction for paying off the principal. However, as you pay off your principal, you own more of the property outright, which builds your net worth. Paying off interest does not build your net worth.

Cheryl Clossick | Clossick Realty LLC | Real Estate One | 1365 E. Michigan Ave | Saline, MI 48176

Cheryl@CherylClossick.com | www. CherylClossick.com | (734) 709-1683