How Do Mortgage Interest Rates Work?
Whether it's a home, auto, business or personal loan – odds are you've had to deal with interest rates. Essentially, the interest rate determines how much it will cost you to borrow money so naturally the higher or lower the interest rate quoted will help determine whether you should agree to the loan. When it comes to home financing, understanding the constantly change interest rate landscape can be confusing. We're here to help make it easy!
Your Level of Risk Plays a Role
If you've ever seen a mortgage ad – whether on TV or in print – you'll notice how the company points out low rates in big bold letters. However sometimes that low rate will only be offered to a select group of people – why? When you apply for a home mortgage, the lender will base your rate on your level of risk. If you have a high credit score, lenders will quote you a better (lower) rate. If you have a poor credit score, your level of risk is higher and for the same loan, you might have to pay a higher interest rate.
The Ever-Changing Market
In addition, the current condition of the housing and Bond market will influence your rate. The prime rate, as reported by The Wall Street Journal's bank survey, is among the most widely used benchmark in setting home equity lines of credit and credit card rates. It is in turn based on the federal funds rate, which is set by the Federal Reserve. The COFI (11th District cost of funds index) is a widely used benchmark for adjustable-rate mortgages.
During the loan application process, your loan officer may discuss the strategy behind when to "lock" your rate. This means that the loan officer will officially tie your loan to a specific rate. Once you lock your interest rate – this is the rate of your loan. Whether the current rates go up or down will no longer affect your application. Keep in mind that locking your rate happens well before the loan funds and sets into motion a time frame to get the financing completed…or you can risk losing your locked rate.
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Fixed vs. Adjustable Interest Rates
When it comes to home mortgages, you may find that there are fixed rate and adjustable rate mortgage programs available.
A fixed rate mortgage
does not change throughout the life of the loan allowing you to always know exactly how much your monthly payment will be. If you plan on staying in your home for a long time or would like to pay off your home – this is likely the best option. If rates go lower than your fixed rate, you can always refinance.
An adjustable rate mortgage
will fluctuate with market conditions. For example, you might start out your loan with a low interest rate but after a set number of years, that interest rate could go up. In many cases, there is no limit to the increase in the rate which can make it difficult for some homeowners to continue making their payments. Adjustable rate mortgages are beneficial in specific circumstances but it is always best to work closely with your loan professional to make sure a program is the best fit for you and your family.
Key Take Away
Hopefully, you understand the role that interest rates play in the home mortgage process. Keep in mind that it is IMPOSSIBLE for any loan professional or lender to predict what the housing market will do. No one can tell you what the future rates will be for certain. When you are quoted a rate for a loan, remember that it was quoted as if you "locked" your rate today and may not be the same tomorrow or a week or month down the road when you actually get ready to "lock" your rate.
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