Mortgage interest rates are not standardized across the mortgage industry. They actually vary from one mortgage lender to the next and from one borrower to the next. Lenders set their mortgage rates in order to offset the risk of borrower default.
Lenders also determine their rates in a way that makes them competitive with other lenders. For example, if a company needed to attract more borrowers, it can simply offer lower mortgage rates and fewer fees than its competitors.
Let’s take a look at five specific factors that can affect your mortgage rate when shopping for a loan.
Risk is one of the primary factors that can affect your mortgage rate. Banking and lending are risky businesses because there is always a chance the borrower will fail to repay his or her debt obligation down the road. This is called default.
Riskier borrowers are charged higher interest rates than the less risky borrowers. You should learn more about risk-based pricing because this is one of the primary factors that will influence your mortgage rate.
But how do lenders measure risk from one borrower to the next? One of the tools they use is the borrower’s credit score.
Credit scores are three-digit numbers that are based on the information found within your credit report. This includes all kinds of information from your borrowing history. If you have the habit of paying all of your bills on time and maintaining relatively low credit-card balances, you most likely have a good credit score. But people who routinely make late payments or skip them altogether tend to have lower scores.
Mortgage lenders use credit scores to analyze risk. A borrower with a high or good score is viewed as a lower risk, while a person with a low or bad score is seen as a higher risk. So this three-digit number is one of the major factors that could affect your mortgage rate.
Size of your down payment
The amount of money you are willing to put down on the loan could also influence your interest rate. And this once again has to do with risk.
Making a bigger down payment results in a lower loan-to-value or LTV ratio. This also reduces the level of risk for the lender. On the other hand, a smaller down payment results in a higher LTV and can therefore result in a higher mortgage rate.
Here is an in-depth explanation of the relationship between down payments and mortgage rates.
The type of home you are buying
Different types of homes have different risk levels associated with them based on the historical likelihood of default. The type of property you are buying can also affect your mortgage rate by extension.
Single-family homes that are bought as a primary residence pose the lowest risk of default. Homes purchased as vacation or second homes tend to have a higher default rate. Mortgage lenders often charge higher rates for riskier properties and impose stricter underwriting guidelines.
The amount of money you are borrowing
Larger home loans are riskier than smaller ones because there is more money involved and therefore a higher potential for loss.
Borrowers who use conforming loans that meet the size restrictions that are used by Freddie Mac and Fannie Mae often qualify for lower mortgage rates than those who use jumbo loans that are too big to be sold to Fannie or Freddie.
Do you have a question about factors that affect your mortgage rate? Click here to get in touch the Kolesar Team today!