The interest rate on your mortgage is one of the most important factors that determines how much your monthly payment will be.
Each month, your rate, expressed as a percentage, is applied to your principal balance, to calculate how much interest you owe. That amount then becomes part of your payment for that month along with a small portion of the principal.
The rates lenders offer you are determined by multiple factors, according to the Consumer Financial Protection Bureau (CFPB), a federal government agency that educates consumers about financial products.
These factors include:
• Your credit score
• The location of the home you want to buy
• The purchase price of the home you want to buy
• Your down payment as a percentage of the purchase price
• Your loan amount
• Your loan term, usually 15 or 30 years
• The type of loan you want (e.g., conventional, FHA or VA)
• Whether your rate is fixed or adjustable
Fixed or variable
If your rate is fixed, it will never change as long as you keep your mortgage. If it’s variable, it could change and as a result your payment could be higher or lower some time in the future.
Some loans have a rate that’s fixed for a certain number of years and then adjusts, so your payment would stay the same until the initial period ended and then it could change.
Adjustable-rate mortgages (ARMs) typically come with caps that protect you from payment shock if market rates rise quickly. These caps limit how much the rate can adjust at each adjustment period and the highest rate you can be charged during the entire term.
When you apply for a loan, you’ll be quoted a rate that’s based on the current market rates on that day. That rate can change until you lock your loan or lock in your rate. Rate locks typically last 30, 45 or 60 days. Usually you can get a longer lock if you pay a fee.
Interest is just one cost of your mortgage. You’ll also typically have to pay closing costs such as a loan origination fee, appraisal fee, lender’s title insurance, loan processing fee, transfer tax, and escrow or settlement fee.
If you don’t have the cash to pay closing costs upfront, you might be able to accept a higher interest rate instead.
Paying a higher rate to avoid closing costs can be good option for some people. You should discuss your personal situation with your loan officer to figure out whether a so-called no-closing-costs loan makes sense for you before you decide.
Your interest rate doesn’t include your closing costs, but your annual percentage rate (APR) does include some of these costs in the calculation. That’s why the APR is usually higher than the interest rate alone.
The APR can be helpful to understand and compare the costs of fixed-rate loans. If your loan rate is adjustable, the APR is not that useful because it measures only the initial rate, which might change later on.
The APR isn’t perfect, but it can be helpful as you compare loans and try to figure out which one is best for your needs. You should always shop around and compare different lenders’ rates and fees.
Another way to compare rates and fees is to examine the disclosures lenders are required to give you when you apply for a mortgage. These disclosures include the type of loan, interest rate, closing costs and other specific details.
Online mortgage calculators can also help you understand interest rates and mortgage payments.
One way to get a lower mortgage rate is to pay discount points. A discount point is equal to one percent of your loan amount. Each point or fraction of a point that you pay will lower your rate by a certain percentage or fraction of a percentage.
To figure out whether it makes sense for you to pay points to buy down your rate, you’ll have to discuss your situation with your loan officer and run various scenarios. If you plan to refinance your loan or sell your home within a few years, paying points might not make sense. If you plan to keep your home and your loan a long time, paying points can be a smart strategy.
Points typically can be paid upfront as part of your closing costs or added to your loan amount.
When you shop around and compare mortgage rates and fees, consider whether each loan includes discount points to lower the rate or a higher rate that covers some or most of your closing costs.
Finally, when you sign your loan documents, confirm that the interest rate on the documents is the rate you believed you were offered. If you notice a discrepancy or have any questions or concerns, don’t hesitate to ask for a clarification. The rate you were promised should be the rate you’re given for your new home loan.
Marcie Geffner is an award-winning reporter, editor, writer and author covering a number of topics including real estate, mortgage and banking. She is currently a full-time freelance reporter. Marcie is a former board member of the National Association of Real Estate Editors and remains an active organization member.
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