The interest rate of a mortgage is one of the most important things to consider, although it shouldn’t be the only thing. You should pay special attention to the interest rate. The bigger the loan amount, the more the interest rate will make a difference.
What is an Interest Rate
If we look at a $100,000 loan, the difference between the two interest rates is $59.41 a month. That’s $21,386.28 over 30 years. For a $500,000 loan, the difference is $297.03 a month, and $106,931.40 over 30 years. The difference ca be staggering. This is why we usually see a wave of refinances when market rates drop by even as little as half a percentage point–people save a lot of money by refinancing.
How Interest Rates Are Determined
Interest rates are a function of risk. The lender, like any prudent investor, looks at the risk-free investments available on the market (such as Treasury bonds). They then add a risk premium to compensate themselves for taking a chance on lending money to a prospective borrower.
While T-bonds are virtually 100% secure, mortgage notes are not. If the borrower defaults, the lender can technically recover their investment, but at a big cost. The lender will not receive monthly payments from a defaulting borrower for a period of time, will have to hire a law firm to foreclose on the house, and then have to pay a real estate agent to sell the home–in the meantime they would be experiencing loses in the form of “opportunity cost” (i.e. not earning a risk-free return from T-bonds while all this is happening). Therefore, the higher the lender’s risk, the higher the interest rate will be.
This is how lenders determine risk; they look at the following parameters:
- Amount of equity in the home,
- Borrower’s credit history,
- Location of real estate,
- Type of real estate being financed,
- Local and nationwide market conditions.
For these reasons, you might compare two exact loans but see a big difference between interest rates based on who the borrower is, the type of real estate it is, the location, and the date the loan was written.
While comparing two rates against each other is simple, what you should really focus on is the interest rate plus other terms of the loan, such as the fixed period, closing costs, and total money out of pocket.
Here are some actions you can take to get better rate offers from lenders:
- Saving up a bigger down-payment, for a purchase;
- Fixing up your house and increasing the home’s appraised value, for a refinance;
- Improving your credit score and taking care of unpaid bills prior to applying for a mortgage;
- Applying for loans when market conditions are favorable to you;
- Applying for loans with multiple lenders, or one reputable mortgage broker, and let your loan officer know that you’re shopping.
These tips will help you get the lowest interest rate.