Sometimes it might seem like interest rates are completely random numbers pulled from thin air. In reality, there are a number of detailed calculations used to determine exactly what the interest rate should be for any given loan. At the heart of this pricing is the idea of risk, how likely a borrower is to repay their mortgage successfully and on time.
If you want to get the absolute best rate for your loan you need to understand how risk is calculated. Here are five of the most common factors used in determining interest rates.
- Loan type. If you compare an FHA loan, VA loan, and conventional loan all of them will be priced differently. Some programs have strict credit and income guidelines that make them a lower lending risk, while others are more generous with their underwriting terms. These guidelines are reflected in the rate.
- Loan term. A shorter loan term means higher payments, but can also lead to a lower interest rate. This is because you’re not borrowing the lender’s money for as long a period of time as you might be with a 30 year note.
- Down payment. Down payment is considered a high indicator of risk. Someone with no down payment is more likely to walk away from a house if they end up in a situation where they have trouble making payments. A larger down payment will be seen as a commitment to hold the property and entitle you to lower rates.
- Credit score. Credit score is one of the most important considerations when it comes to your interest rate. Think of it as an estimation of how reliable you’ll be when it comes to paying off your loan. You should practice good credit habits and check your credit report regularly to make sure you have the best score possible.
- Rate Type. If you’re planning on living somewhere for a short time an ARM may be more up your alley. These loans have lower initial rates but periodically adjust based on market conditions. Because rates can be higher in the future lenders tend to price these loans lower upfront.
When shopping for a loan remember that interest rate isn’t everything- there are numerous costs and fees associated with your loan that must also be taken into consideration as well. A fantastic rate might have you paying numerous fees in order to get that number.
Still have questions? Check in with one of our Cendera Mortgage Bankers. We enjoy making loan terms transparent and easy to understand for our borrowers.