Factors Affecting Mortgage Interest rates
As a rule of thump, your interest rate will be higher when either or a compination of the following happens:
Length of Loan increases, Lock In Period increases, Lower or No Down Payment, Pay Less or No Discount Points, Pay Less or No Closing Costs, Low Credit Scores (FICO) and High Income to Debt ratios.
Your interest rate will be lower when either or a compination of the following happens:
Length of Loan decreases, Lock In Period decreases, Higher Down Payment, Pay More Discount Points, Pay More Closing Costs, High Credit Scores (FICO) and Low Income to Debt ratios.
The amount of your loan can also increase your interest rate if the amount financed exceeds the conforming loan limits established by Fannie Mae and Freddie Mac. The conforming loan limit changes at the beginning of each year and currently are at $417,000.
Shorter loans, such as 20 year or 15 year note, can save you thousand of dollars in interest payments over the life of the loan, but your monthly payments will be higher. An adjustable rate mortgage may get you started with a lower interest rate than a fixed rate mortgage, but your payments could get higher when the interest rate changes.
A larger down payment – greater than 20% – will give you the best possible rate. Down payments of 5% or less should expect to pay a higher rate as you are starting with less equity as collateral. If you’ve got the cash now and want to lower your payments, you can pay on your loan to lower your mortgage rate. In exchange for more money upfront, lenders are willing to lower the interest rate they charge, cutting the borrower’s payments. Closing costs are fees paid by the lender, if you don’t want to pay all of the closing costs, expect a higher rate which will pay the lender additional interest over the life of the loan.
Credit quality and debt-to-income-ratio affect the terms of your loan through FICO Score. If you have good credit and your monthly income far surpasses your monthly debt obligations, you will get approved at a lower interest rate. However, if your monthly income barely covers your minimum debt obligations, even if you have a good credit report, you will not receive the lowest available interest rate.
Annual Percentage Rate (APR)
Simply put, APR is the true cost of the loan to the borrower expressed in the form of a yearly rate.
A tool used to compare loans across different loan programs is the Annual Percentage Rate (APR). The Federal Truth in Lending law requires mortgage companies to disclose the APR when they advertise a rate. It is designed to represent the true cost of the loan to the borrower, expressed in the form of a yearly rate. The purpose is to prevent lenders from hiding fees and upfront costs behind low advertised interest rates.
One confusing aspect of APRs is that the APR on 15 year loans will carry a higher relative rate due to the fact that the points are amortized over the 15 year term rather than the 30 year term. When a Regulation Z (the mortgage company’s disclosure of cost for the loan) is prepared for a buyer/borrower, the prepaid interest is also included in the APR calculation.
Even lenders admit it is confusing since it includes some, but not all, of the various fees and insurance premiums that accompany a mortgage. The rules for calculation of this number have not been clearly defined, so APRs vary from lender to lender and from loan to loan, depending on which types of fees and charges are included. In addition, the APR model is flawed in that when a product is variable and tied to a market index, the index is assumed to never change. This obviously is an invalid assumption that can lead again to a number, which in fact can not be compared, from one quoting source to another.
Finally, the APR won’t tell you anything about balloon payments and prepayment penalties or how long your rate is locked for. You can use APRs as a guideline to shop for loans, but you should not depend solely on the APR in choosing which loan is best for your needs.
Lock In Your Interest Rate
A lock, also called a rate lock or rate commitment, is a lender’s promise to hold a certain interest rate and a certain number of points for you, usually for a specified period of time, while your loan application is processed. Depending upon the lender, you may be able to lock in the interest rate and number of points that you will be charged when you file your application, during processing of the loan, when the loan is approved, or later.
Closing Costs Explained
Closing costs are the actual expenses that the lender incurs in the origination of a new home loan. Some of the costs are related to your loan application, such as the expense of a credit report on all applicants. Other fees are related to the house itself, such as the property appraisal. Others are payment to the lender for processing your application, such as the loan origination fee.
Unless the seller offers to pay them for you, these expenses are charged to the buyer and often runs between 2 and 3 percent of the amount being borrowed.
Common closing costs can include processing and underwriting fee, mortgage insurance premium, appraisal fee, the cost of a credit report, tax service fee, application, commitment, wire transfer fee, etc. Escrow accounts are also required for many loans for homeowners insurance, real estate taxes, and homeowners associations and require cash deposits at closing.
After your initial meeting with a mortgage professional, you should receive a Good Faith Estimate (GFE) that shows all of the closing costs associated with your mortgage application. If a credit report costs $100 at one shop and $20 at another, but the second lender’s deal is better overall, point out the discrepancy and ask the preferred company to lower its charge. Just remember, any third party fees have been previously negotiated and established between the mortgage company and third party.
Should I Pay Points
A point, which equals 1% of the total loan amount, is an upfront fee that reduces your monthly interest rate and total interest due over the life of a loan. This means that a one point loan will always have a lower interest rate than a no point loan. Paying points is in essence a trade off between paying money now versus paying money later.
Deciding whether to pay points depends on how long you are looking to keep the loan. We suggest paying points up front if you plan on keeping the loan for at least four years to ensure that you recoup the costs through lower monthly payments. If you think that you might move within the next four years or might want to refinance because the market rate is declining, then you probably would be better off with a no point loan.
Lenders allow you to choose amongst a variety of rate and point combinations for the same loan product. Therefore, when comparing rates from different lenders, make sure you compare the associated points and rate combinations of the offered program. The published Annual Percentage Rate (APR) is a tool used to compare different terms, offered rates, and points among different lenders and programs.