5 Factors That Affect Your Mortgage Rate

by Christy Bieber | Published on Aug. 17, 2021

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You may be surprised at some of the things that affect your mortgage interest costs.

If you are applying for a mortgage loan, you'll want to shop around to find one offering the lowest interest rate and best terms. As you go into the process, it can be helpful to know some of the things that affect the interest rate you'll be charged.

Here are five factors that could determine the interest rate you'll pay to borrow for a home.

1. Economic conditions

Many external factors impact the national average mortgage rates, which in turn affect the rate you are charged.

They include the yield on 10-year treasury bonds because mortgage rates tend to track with those rates pretty closely in most cases. That happens because mortgage loans are often packaged as investment products, and investors who buy mortgage-backed securities are typically interested in these bonds as an alternative. The monetary policy of the U.S. Federal Reserve (the nation's central bank) also affects rates, as does supply and demand for mortgage loans.

You can't control these external factors. But you can keep tabs on national mortgage rates so you can try to be strategic about when to apply for a home loan. Waiting for rates to hit rock bottom doesn't always work since it can be hard to predict when that will happen. But you probably want to avoid getting a loan when rates are near record highs.

2. Your credit score

Your own personal financial credentials also have a big impact on the rate you'll pay -- and your credit score is one of the most important factors.

If you have a credit score of around 720 or higher, you should have access to a mortgage from almost any lender at a competitive rate. But if your score is in the 500-to-600 range, then you may want to look at government-backed loans, as they may be the only affordable options. Government-backed loans, like FHA loans, are guaranteed by a government agency such as the Federal Housing Administration. This guarantee reduces the risk to lenders because if you can't pay your mortgage, the agency that backed the loan will repay the lender (though you'll face financial consequences). That makes qualifying for a government-backed loan easier.

3. Your loan term

The length of your loan term also affects your rate. Loans with shorter payoff times tend to have lower interest rates than those with longer ones.

That's because there's less risk to lenders with a short-term loan. There's less of a chance rates will rise dramatically during a short payoff timeline. And there's a reduced chance that something will happen that interrupts your ability to pay your loan.

You'll also build equity in your home more quickly with a loan that has a shorter payoff time. (Equity is the difference between what your home is worth and what you owe on your mortgage. It's basically the portion of your home's value that you truly own.) This further reduces your lender's risk since you'll have more money at stake. And there's less of a chance your loan balance will be higher than what you could sell your home for.

4. Your down payment

The more money you put down, the less risky a loan is for a lender. Again, the risk is reduced because you have more skin in the game -- and because there's a smaller chance the lender would be unable to sell the home for enough to repay the remaining loan balance.

Since a larger down payment means less risk to a lender, borrowers who put more money down are often charged a reduced interest rate compared with those who have small down payments. With a larger down payment, you may also have a broader choice of lender -- and the more lenders you can compare quotes from, the more likely it is you'll get a lower rate.

5. Other debts you have

If you have a lot of debt already, then lenders will feel that giving you a mortgage is riskier. As a result, your interest rate may be higher.

The good news is, you can take steps to reduce your debt over time. And if you aren't happy with some of these other factors, such as your down payment savings or credit score, you can work on improving them before you apply for a loan.

The more steps you take to improve your credentials as a borrower, the lower your interest rate -- and total borrowing costs -- should be in the end.

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