You see the advertisements everywhere: This bank offers one mortgage interest rate, while that bank offers a different one, and the credit union down the street offers yet another drate. Why the difference? Determining an interest rate for a home mortgage loan takes into account many factors, on both the borrower and lender sides. Even your location has an impact on the interest rates. Examining all of these factors is crucial in order to get the best rate for your mortgage.
Why do rates differ depending on the lender?
No two mortgages are the same, and the same can be said for mortgage lenders. These differences can shape your mortgage — and interest rate — which results in varying rates.
Competition among lenders: Like any other industry, lenders want your business, so they will take steps to make that happen. One way is offering lower interest rates than their fellow lenders.
Risk assessment: When lending you money, financial institutions take a risk on whether you will repay your loan. To minimize their risk, they put together their own risk assessment guidelines, which they follow when structuring your loan offer. If they feel confident you will repay your loan as agreed, you could receive a lower mortgage interest rate. However, if they think your loan is risky, they may increase your rate.
Funding costs: At its onset, every loan costs the lender money and time to go through the application and funding process. They recoup these costs through the mortgage rate.
Operational costs: Like every business, there is a day-to-day cost to running a financial institution— these range from labor to utilities to building maintenance and so on.
Profit margins: Making money is what most businesses hope to achieve, and lenders are no different. Maximizing those profits remains a top priority, and that can affect what mortgage rates lenders offer to their clients.
As you can see, there are many factors affecting the types of mortgage rates you receive from different lenders. That’s why shopping around is essential before signing your mortgage application on the dotted line.
Why is my rate different from the advertised rate?
Lenders want to attract clients to their business, so they will advertise great deals to get you in the door. But, as with most advertisements, those great deals come with specific terms you must meet to receive the deal.
And, just as no two mortgage lenders are the same, no two borrowers are the same. In fact, every borrower brings a unique set of circumstances to financing that affects mortgage interest rates.
Credit rating: For lenders, credit scores reflect a borrower’s creditworthiness or the borrower’s financial stability. The higher your credit score, the more likely you are to repay your mortgage loan as agreed. A borrower with a low credit score may present a bigger risk to the lender.
Loan terms: Oftentimes, when a lender offers its lowest rates, it will do so only if the loan is repaid within a specific time. Not surprisingly, many times, that time limit is shorter rather than longer, making it more difficult for many borrowers to repay on time. In order to finance their mortgage for a longer timeframe, they will have to agree to a higher interest rate.
Loan-to-value (LTV) ratios: The LTV ratio compares how much your mortgage loan will be to the overall value of your home. The lower your LTV ratio, the lower your mortgage interest rate usually is.
As the borrower, you have some flexibility in changing these factors in your favor. For instance, you can take steps to improve your credit rating. Also, you can save more to increase your down payment and, thus, lower your LTV ratio.
APR versus interest rate
When finalizing a mortgage loan, many homeowners may be surprised to see the interest rate they expected as well as an annual percentage rate, or APR. The quoted interest rate is the amount of money you pay on the mortgage principal, the amount you borrowed, to borrow the money. The APR represents the total cost of the loan, meaning the total of the principal plus all interest and fees for the length of the loan.
To calculate the APR, you need to add the total fees and interest paid for the life of the loan. Divide this amount by the total loan amount, the principal plus closing costs. Then divide that number by the number of days in the loan term. Take that number and multiply it by 365, and then multiply that result by 100.
Sound confusing? Consider you have a 30-year mortgage for $200,000 with a 4.5% interest rate. You paid closing costs of $4,800. In addition, your origination fee was 1%, and you paid for 1 discount point (which generally cost approximately 1$ of the mortgage amount). There also was an additional $800 in fees. As a result, the APR would be 4.703%.
Do rates vary by state?
Where you live can affect a lot of factors related to your home: the home’s value, the cost of homeowner’s insurance and, yes, your mortgage interest rate. Several factors are influencing your interest rate that relate to where you live.
Foreclosure rates: If you live in an area with high foreclosure rates, lenders will want to reduce their risk of default by offering higher interest rates.
Different laws: State legislatures may pass laws to impose fees on lenders, which lenders then pass on to borrowers through interest rates.
Population: The number of people living in your hometown can affect how much competition there is for your business, which, as stated previously, can affect the interest rates available to you. If you live in a small town with a limited number of lenders, those lenders may offer lower rates to attract customers. Of course, the same could be said for big cities. While there are a lot more people, there are usually also a lot more lenders, who also offer lower rates to attract customers.
If I lock my rate, can I renegotiate if rates decrease?
Because mortgage interest rates fluctuate on a regular — essentially daily — basis, you may wonder if you need to sign right away to secure a low rate. To give yourself more time, you may consider getting a rate lock. Basically, you pay the lender to guarantee your rate for a specific amount of time.
There can be pros and cons to getting a rate lock. The most obvious advantage is that if rates increase, you will benefit from the lower rate. Of course, the opposite provides the con: If rates decrease, you are stuck with a higher rate, unless you purchased a float-down provision with your rate-lock agreement. This provision means you can renegotiate if the rates drop. If you have the option to cancel a rate lock, you may be charged a fee to do so.
It’s important to note that a rate lock only guarantees the lender will offer you that rate; you still have to qualify for it, which may not happen.
A final thought
When it comes to mortgage interest rates, you will find a variety of them available through various lenders. Before signing the paperwork, though, you need to research the different rate offers to examine the fine print and see what each one entails. Only then can you determine which rate will be best for your financial needs.