How Your Mortgage Rate is Calculated
How is my mortgage rate calculated and what can I do about it?
This goal includes not only finding a loan that meets your financial needs, but also getting approved for a low mortgage rate. Controlling the rates you are offered during this process is impossible, but there are ways you can educate yourself ahead of time. By being informed, you can find the best mortgage rate available. Keep in mind that failing to do your research can mean tens of thousands of extra dollars over the course of your home’s repayment. So how do lenders determine the mortgage rate that you’re offered, and what can you do to ensure that you are given the lowest rate possible?
There are three major factors contributing to your mortgage rate that you cannot control.
1. Federal Interest Rate Trends
The Federal Reserve doesn’t set mortgage interest rates, but it does determine federal funds rate. The federal funds rate provides lenders with a benchmark for the interest-based products that they provide. This includes mortgages. Depending on which way the Fed trends, you can count on mortgage rates to follow.
Another uncontrollable factor is inflation. Inflation has a direct, cyclical relationship with mortgage rates. In a vicious cycle, mortgage rates will climb as inflation does; as mortgage rates climb, inflation will be further affected.
Based on things like foreclosure laws and differences in population, mortgage lenders may offer slightly different rates from state to state. While you may have some control over the area in which you choose to buy your home, there are a number of reasons that this is a hard subject to concede on. If your job, family, etc. limits your ability to relocate, you can be stuck paying higher rates simply because of where you live.
Relocating to a different county or city is easy, but to consider relocating to a different state for the sake of lower mortgage rates is likely not a viable option.
The good news is that there are many factors that you can control. These elements are all considered by mortgage lenders when underwriting your new loan and determining the rate for which you qualify. Consider improving all or some of them before applying for a mortgage in order to receive the best rate possible.
1. Credit Score
Having a high credit score is a major indicator of creditworthiness. Borrowers with a high credit score are considered to be a less risky investment to lenders, which qualifies them for lower mortgage interest rates. In the months or years leading up to a mortgage application, you should do your best to raise your credit score as much as possible.
2. Debt-to-Income (DTI) Ratio
In very general terms, lenders want applicants to have a debt-to-income (DTI) ratio of 36% or less. Some lenders will have unique preferences, but a high DTI will always throw up a red flag for lenders and signal a risky investment. This will increase the mortgage rate offering. A DTI higher than 43% will almost automatically mean a mortgage loan denial.
3. Home Price
A jumbo mortgage loan will oftentimes be required for expensive homes, or those whose price exceeds the FHA conforming limit which is $548,250 as of January 1, 2021 for most of the country. While the price can be a factor in the rate you are offered, it is rarely the only one.
4. Loan-to-Value (LTV) Ratio of Your Home
Loan-to-Value, or LTV ratio is an indicator of your home’s value versus your actual loan amount. This factor can be lowered by buying a home below market value and/or making a larger down payment at purchase. The higher the LTV ratio is, the riskier the investment is for lenders, and therefore the mortgage rate offered will be higher.
5. Mortgage Loan Term
Finally, lenders tend to offer different rates based on your chosen loan terms. For example, 15-year mortgages will usually have lower rates than 30-year mortgages, since the length of the loan is shorter. Another example is that variable interest rate loans tend to have lower rates at the outset than their fixed-rate, predictable counterparts.
While there are many items at play regarding your mortgage rate, there are many factors that you can control. By working to improve the factors that you can control, you can often lower your mortgage rate by a significant amount; even dropping your rate by a quarter of a percent can save you tens of thousands of dollars during the course of repayment of your mortgage. As for the elements that you cannot control, you should take solace in the fact that many homebuyers around you are in the same boat.
Fixed Rate vs. Adjustable Rate Mortgages
Fixed rate vs. adjustable rate mortgage: which is best for me?
There are a variety of loan types offered, each designed to suit different mortgage needs. Four of the most common types are: fixed rate mortgage, adjustable rate mortgage, FHA loans, and VA loans. Let’s briefly explain the latter two, and then focus on the former as a comparison.
Federal Housing Administration (FHA) loans can help homebuyers who do not or cannot make the traditional 20% down payment and/or have a less than perfect credit score. With an FHA loan, you can put down as little as 3.5% at closing. VA loans are reserved for veterans, active-duty personnel, reservists, National Guard members, and sometimes surviving spouses. This loan requires no down payment and an ability to buy with less-than-perfect credit.
1. Fixed Rate Loan
Fixed rate mortgages are the most common loan option, and the most sought out by borrowers. As suggested in the name, the rate stays the same throughout the lifetime of your loan. Many borrowers will start out with a 30-year fixed, but there are other options such as 25, 15, and 10-year options.
Fixed rate loans offer affordable, competitive interest rates that keep borrowing costs low. They are also predictable and budget friendly as borrowers enjoy the same locked interest rate for the entire term of the mortgage. Finally, they are very straightforward, and are a great option for home buyers who would benefit from uncomplicated loan terms and paperwork.
2. ARM Loan Options
Adjustable Rate Mortgages (ARMs) boost your buying power with lower rates and flexible terms. This type of loan gives you a lower, fixed interest rate for the initial 5,7, or 10 years, and then afterwards your rate and monthly payment can change annually based on current interest rates during specified intervals following the initial “fixed” period. For example, a 5/6-month ARM interest rate is fixed for five years and then can adjust at the end of the initial 5-year term and every six months after that for the remaining term of the loan. NewRez offers a wide variety of ARMs to fit your unique needs, including 5/6-month, 7/6-month and 10/6-month ARMs.
It is beneficial to consider Adjustable Rate Mortgages for several reasons. First, ARM Loan Options generally offer the lowest mortgage rates possible. 7/6-month ARM rates are typically significantly lower than 30-year fixed rate mortgages. The 7/6-month ARM rate would be fixed for seven years, potentially saving you money that you could use to pay off another debt or add to your retirement savings.
Another reason to consider an ARM is if you plan to sell your home in just a few years. If you intend to sell your new home before the loan adjusts, you may be able to save money with an ARM over a fixed-rate loan. For example, if you know that you will be switching jobs soon, or getting transferred to a new area, an ARM would be the better option. Because ARMs have low initial rates, they are the better option for mobile professionals, homeowners who plan to upsize or downsize, and anyone who will live in their home for the short-term.
Finally, an ARM is a great option if you want “more house.” By applying for an Adjustable Rate Mortgage, there is a possibility that you will qualify for a higher loan amount and can buy a home with a larger price tag.
There you have it. While both Fixed Rate Loans and Adjustable Rate Mortgage Loan Options are great choices, the information outlined above can give you a better idea of which is the best option for you. Now that you have the tools to make an educated decision, there is only one thing left to do: start saving for that down payment! Reach out to our team of mortgage professionals to get started.
Comparing Mortgage Rates
What else should I look at beyond the interest rate?
It’s finally time…you’ve decided to hit the gas and either purchase a home or refinance your current one—congratulations! The next step may be to find a loan officer to help you through the next steps and get you to the closing table soon! Don’t be afraid to ask clarifying questions about the details of an offer before submitting an application.
1. Explore Your Rate
At NewRez, we create an offer for you based on a number of factors and always strive to give you the best rate possible.
One tool that lenders use is points, or fees that borrowers have to pay at closing. One point equals one percent of the principal amount of a home loan. For example, if the mortgage is $250,000, one point is equal to $2,500. Lenders will increase the number of points in order to lower the rate so that the offer looks better than a competitor’s, but at closing it often equals out. When factoring in a rate and APR when it comes to the impact of points, lower closing fees are a result of a higher rate, while high closing costs come with a lower rate. Take time to ask clarifying questions about the details of your loan offer and ask your Loan Advisor to explain things in layman’s terms if you do not fully understand real estate jargon.
There are scenarios in which points are beneficial to borrowers, especially if rates increase in the early life of a loan. However, this would be hard to predict as it would depend on a borrower predicting that a rising rate environment was on the horizon and planning accordingly at the time that the home was bought.
2. Come Prepared & Educated
As with any large purchase, you will likely come across an offer that seems too good to be true. For example, a lesser-known lender could be advertising substantially lower rates than their more reputable counterparts. In these circumstances, it is important to understand not only the rate, loan structure and term, but also the fees and subsequent costs involved. Insist on transparency from the lender and come prepared with questions in order to avoid surprises at closing. View our other articles about mortgage terminology and be sure to ask the lender about secondary items, such as lending and appraisal fees, as well as title services or lenders title insurance costs. Thoroughly read the loan estimate and clarify anything that is unclear before signing any paperwork.
Continue to ask questions of your loan officer even if this isn’t your first time going through the mortgage loan process. Do your research! Identify all the costs and ask questions about anything that isn’t immediately clear to you.
Mortgage 101 Recap
What goes into a mortgage and why should I care?
When looking into buying a home, there are three mortgage factors that should be in your notes: the closing costs, the monthly payment, and the rate. Mortgage rates are an important part of understanding what a mortgage is. The lower your approved rate, the less you’ll spend on the home as you pay back your loan.
These savings can be extremely significant, even with a small percentage decrease. For example, on a $250,000 mortgage, a 0.25% rate reduction could save you nearly $13,000. Reduce that rate by half a percent, and you are saving over $25,000. By being informed about what goes into your mortgage rate, you can obviously stand to save some serious cash; so, what are some other things to keep in mind as you move forward?
1. What is a mortgage?
A mortgage is a loan for real estate. Just like any loan, you need to apply and be approved before you can borrow money from a lender, such as NewRez, which you will payback over a set number of years.
Lenders want to avoid a risky investment and will examine a number of factors before you can be approved or rejected for the loan. These items include income, credit score, and debt-to-income ratio.
Since your repayment of the loan is monthly, the lender will make sure that you have sufficient and consistent income to pay your bill each month. They will require documentation, which can include the last two years of W2’s, current pay stubs, and your last two federal tax returns.
Your credit score is available to most lenders and will give them an idea of your financial responsibility and history of paying off debts. A credit score of 740 or above will usually put you in fine standing to be approved. However, a lower score can mean a higher interest rate or even a turndown of the loan.
Finally, debt-to-income ratio, or DTI, will be taken into consideration. This is a calculation of your total gross monthly debts or payments divided by your total gross monthly income. The lower this number is, the less risky you are to lenders; this means eligibility for a lower rate and approval. If your number is high, it is recommended that you pay off large debts as soon as possible or increase your income.
2. What costs are included in my monthly mortgage payment?
Your mortgage is comprised of several elements: principal and interest, and possibly taxes and insurance. There are also other costs and expenditures to consider, like the down payment.
Your down payment, similar to other loans, is the amount that you pay up front. Unlike other loans, though, this is generally 20% of the property’s cost. This is sometimes flexible, and there are many lenders that allow for less down at closing or allow you to put down more money if your credit is less than perfect. If you do not have 20% to put down, you may need Private Mortgage Insurance (PMI) which your lender can arrange. This protects the lender in the event that you default on your loan.
The principal is the amount of money that the lender will loan you. This money is not loaned for free and is charged a rate called interest. The interest percentage that you will be charged is determined before closing and may stay the same or fluctuate over the course of your loan, depending on the type of loan that you are approved for.
You will pay property and school taxes once you own your home. These go towards things like your city, school district, and road construction. Another element that goes along with homeownership is insurance. There are several types of insurance, including homeowner’s insurance. This insures your home and family against damage and/or loss in the event of a fire, theft, or other emergency.
A mortgage can seem complicated, but NewRez is here to help you feel confident in the mortgage process from start to finish. The information above should help you begin to understand what you are applying for, and answer some of the common mortgage questions so that you’ll be ready and in the know when it’s time to buy a home.
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