How Do Lenders Calculate Mortgage Rates?
- The borrower's credit history and financial situation helps lenders calculate the mortgage rates they offer. Borrowers that are perceived as high risk due to poor credit history or low income are likely to face higher interest rates than borrowers that have paid off bills and other debts on time and have higher incomes. If you currently carry a large amount of debt, the interest rates you face on a mortgage will likely be higher than if you were debt-free. Anything that indicates that you might be likely to miss a payment at some point will tend to give lenders cause to charge higher interest rates.
- The duration of the mortgage is one of the most important factors in determining the interest rate. Most mortgages lasts for 15 year or 30 years. The shorter the mortgage, the lower the interest rates is likely to be. For instance, if average 30-year mortgage rates are 4.5 percent, the average 15-year rates might be around 3.75 percent. While the difference in rates might not seem large in terms of percentage points, a difference of half a percent can amount to thousands of dollars over time.
- A down payment is a payment a borrower makes toward the value a property when taking out a mortgage to reduce the amount of money he must borrow. For instance, a homebuyer that makes a $20,000 down payment on a home that costs $100,000 would have already own 20 percent of the home's equity and would only need to borrow $80,000. The larger the down payment you make, the lower your interest rate is likely to be.
- The prevailing short-term interest rate, sometimes called the prime rate, is used by banks as a baseline to calculate other interest rates such as mortgage rates. In other words, mortgage lenders use the prime rate to determine a reasonable baseline mortgage rate and then adjust the rate up or down based on factors relevant to a particular borrower, such as credit history, down payments and duration of the loan. The prime rate can be affected by actions of the Federal Reserve. If the Federal Reserve raises the interest rates it controls, it can cause the prime rate and therefore other interest rates in the economy to rise.