Mortgage rates are susceptible to several factors, which can play a heavy hand in your purchase of a new home. These factors can affect your rate so much so that one day you are ready to buy your dream home, and the next day you can't afford it anymore. The converse can also be true in a buyer's market. During low rates, a refinance might save you hundreds of dollars a month. What exactly are the factors that change the percentage of your possible
home loan? The answer is several factors, both controllable and uncontrollable.
Uncontrollable Factors of Mortgage Rates
Unfortunately, several factors that affect interest rates are beyond your control. These include the following factors:
- The Prime Rate: Lenders usually give this rate to the best customers, and it tends to start at 3 percent above the Federal Reserve's rate. You will often see advertisements for interest at specific points above or even below prime, but only people with excellent credit can get these rates. The amount of debt you have in comparison to your income can also affect what rate you will get. Most individuals should consider the prime rate as the starting point for comparing home mortgage lenders.
- The Federal Reserve: Most financial institutions borrow money from the Federal Reserve, or the FED, to fund home mortgage loans. The FED sets a target interest rate for bank-to-bank loans so that it can profit from the transactions. If your lender borrows from the FED, it will need to charge a higher interest rate than the FED charged in order to gain profit. The FED often sets the base rate, or the discount interest rate, based on the economy. For example, the FED will lower its interest rate during a recession.
- Supply and Demand: Both factors work together to influence the interest rate. The more houses on the market, the lower the interest rate will usually be. When fewer homes are for sale, lenders can charge a higher interest rate. Consumers can also dictate supply and demand. The more people wanting to buy homes, the higher the interest rate a bank can charge because more people are applying for home loans. High supply can also result in home prices rising.
- Economic Growth and Inflation: A slower economy will see lower interest rates in general, as the government and lending companies push for secure investments that will spur growth. Alternatively, fast growth leads to high inflation and interest rates. This can start with the FED raising rates to try to slow inflation to protect the strength of the dollar.
Controllable Mortgage Rate Factors
While it may seem like you have little control over the interest rate, you can take steps to get the best mortgage rate possible.
- Your Credit Score: Most people know that their credit score plays a large role in how much below or above the prime rate their loan will be. If you have poor credit, you may have to pay well over the prime interest rate to secure a mortgage. Lenders call this type of home loan a subprime loan. If you have excellent credit, which is usually 720 or higher, you may be able to score a home loan under the prime rate, though this is rare. The way your credit score will affect your home loan interest rate depends on each lender.
- Available Credit: People without credit history often have a lower credit score than people who have misused credit. This leads many individuals to apply for every type of credit available, including credit cards and unsecure loans. However, lenders consider how much credit a person has available when they determine your mortgage rates because people often use all their available credit and can no longer afford their mortgage. To control this factor, keep your debt balances low and do not apply for every credit card offer that you get. Try to have little or no running balances on your credit cards.
- Debt to Income Ratio: Lenders consider your overall debt to income ratio. For mortgages, this ratio is a double blow: It will affect the interest rate the bank offers you, and the bank will consider this amount to determine how much money it will loan you. Generally, you should keep your debt to income ratio below 36 percent. Mortgage lenders determine your debt to income ratio by adding up the annual total of all your debt, including your car, rent, credit cards and student loans. Then they total your income, including your salary, dividends, bonuses, alimony and other sources. Once they have these figures, they divide your debt by your income and multiply the answer by 100 percent. The higher your debt to income ratio, the higher your interest rate.
Get the Best Interest Rate
Mortgage rates change on a regular basis, so you'll want to shop around and compare different lenders. Each lender will determine your risk differently, and it could save you thousands of dollars over the life of the loan to work with the lender willing to give you the lowest interest rate. Continue working on the factors that you can control while considering the ones you can't control. To see how the interest rate can affect your home loan, use our
mortgage calculator.
