Interest Rates - Characteristics that affect your rate

If you are like most people, you want to get the lowest interest rate that you can find for your mortgage loan. But how is your interest rate determined? That can be difficult to figure out for even the savviest of mortgage shoppers.

Knowing what factors determine your mortgage interest rate can help you better prepare for the homebuying process and for negotiating your mortgage loan. Even saving a fraction of a percent on your interest rate can save you thousands of dollars over the life of your mortgage loan.

How does my credit score affect my ability to get a mortgage loan?

Answer: Your credit score, as well as the information on your credit report, are key ingredients in determining whether you’ll be able to get a mortgage, and the rate you’ll pay.

Your credit report and your credit score are two different things. Your credit score is calculated based on the information in your credit report. Higher scores reflect a better credit history and make you eligible for lower interest rates. You have many different credit scores, and there are many ways to get a credit score. However, most mortgage lenders use FICO scores. Your score can differ depending on which credit reporting agency is used. Most mortgage lenders look at scores from all three major credit reporting agencies – Equifax, Experian, and TransUnion – and use the middle score for deciding what rate to offer you.

Errors on your credit report can reduce your score artificially – which could mean a higher interest rate and less money in your pocket – so it is important to check your credit report and correct any errors well before you apply for a loan.

Your credit score is only one component of your mortgage lender’s decision, but it’s an important one. Other factors include:

  • Credit report
  • Credit history with that lender
  • The amount of debt you already have
  • How much you have in savings
  • Your total assets
  • Current income

Tip: Don’t apply for a lot of new credit in a brief time, especially if you are getting ready to get a mortgage. Doing so may negatively affect your score. Your credit score may decline if you have too many credit accounts. It can also go down if you apply for or open many new accounts in a brief time. However, when you request your own credit report, or when your existing creditors check your credit report, those requests to see your credit report should not hurt your score.


Here are seven key factors that affect your interest rate that you should know


  • 1 - Credit scores

    1 - Credit scores


    Your credit score is one factor that can affect your interest rate. In general, consumers with higher credit scores receive lower interest rates than consumers with lower credit scores. 

    Lenders use your credit scores to predict how dependable you’ll be in paying your loan. Credit scores are calculated based on the information in your credit report, which shows information about your credit history, including your loans, credit cards, and payment history.


    Before you start mortgage shopping, your first step should be to check your credit and review your credit reports for errors. If you find any errors, dispute them with the credit reporting company. An error on your credit report can lead to a lower score, which can prevent you from qualifying for better loan rates and terms. It can take some time to resolve errors on your credit reports, so check your credit early in the process.

  • 2 - Home location

    2 - Home location


    Many lenders offer slightly different interest rates depending on what state you live in. 


    Different lending institutions can offer different loan products and rates. Regardless of whether you are looking to buy in a rural or urban area, talking to multiple lenders will help you understand all the options available to you.

  • 3 - Home price and loan amount

    3 - Home price and loan amount


    Homebuyers can pay higher interest rates on loans that are particularly small or large. The amount you will need to borrow for your mortgage loan is the home price plus closing costs minus your down payment. Depending on your circumstances or mortgage loan type, your closing costs and mortgage insurance may be included in the amount of your mortgage loan, too. 


    If you’ve already started shopping for homes, you may have an idea of the price range of the home you hope to buy. If you’re just getting started, real estate websites can help you get a sense of typical prices in the neighborhoods you’re interested in.

  • 4 - Down payment

    4 - Down payment


    In general, a larger down payment means a lower interest rate, because lenders see a lower level of risk when you have a larger stake in the property. So, if you can comfortably put 20% or more down, do it – you’ll usually get a lower interest rate.


    If you cannot make a down payment of 20 percent or more, lenders will usually require you to purchase mortgage insurance, sometimes known as private mortgage insurance (PMI). Mortgage insurance, which protects the lender in the event a borrower stops paying their loan, adds to the overall cost of your monthly mortgage loan payment. 


    As you explore potential interest rates, you may find that you could be offered a slightly lower interest rate with a down payment just under 20 percent, compared with one of 20 percent or higher. That’s because you’re paying mortgage insurance – which lowers the risk for your lender.


    It’s important to keep in mind the overall cost of a mortgage. The larger the down payment, the lower the overall cost to borrow. Getting a lower interest rate can save you money over time. But even if you find you’ll get a slightly lower interest rate with a down payment less than 20 percent, your total cost to borrow will likely be greater since you’ll need to make the additional monthly mortgage insurance payments. That’s why it’s important to look at your total cost to borrow, rather than just the interest rate.


    Make sure you are factoring in all the costs of your loan when you are shopping around in order to avoid costly surprises.

  • 5 - Loan term

    5 - Loan term 


    The term, or duration, of your loan is how long you have to repay the loan. In general, shorter-term loans have lower interest rates and lower overall costs, but higher monthly payments. A lot depends on the specifics – exactly how much lower the amount you’ll pay in interest and how much higher the monthly payments could be, depends on the length of the loans you're looking at as well as the interest rate.

  • 6 - Interest rate type

    6 - Interest rate type


    Interest rates come in two basic types: Fixed or Adjustable (ARM).


    Fixed interest rates don’t change over time.


    Adjustable rates may have an initial fixed period, after which they go up or down each period based on the market.


    Your initial interest rate may be lower with an adjustable-rate loan than with a fixed rate loan, but that rate might increase significantly later.

  • 7 - Loan type

    7 - Loan type


    There are several broad categories of mortgage loans, such as: Conventional, FHA, USDA, and VA loans. Lenders decide which products to offer, and loan types have different eligibility requirements. Rates can be significantly different depending on what loan type you choose. Talking to multiple lenders can help you better understand all the options available to you.

One more thing to consider - The trade-off between points and interest rates

As you shop for a mortgage, you’ll see that lenders also offer different interest rates on loans with different “points.”

Generally, points and lender credits let you make tradeoffs in how you pay for your mortgage and closing costs.

Points, also known as discount points, lower your interest rate in exchange for an upfront fee. By paying points, you pay more upfront, but you receive a lower interest rate and therefore pay less over time. Points can be an appropriate choice for someone who knows they will keep the loan for a long time.

Lender credits might lower your closing costs in exchange for a higher interest rate. You pay a higher interest rate and the lender gives you money to offset your closing costs. When you receive lender credits, you pay less upfront, but you pay more over time with the higher interest rate. Keep in mind that some lenders may also offer lender credits that are unconnected to the interest rate you pay – for example, a temporary offer, or to compensate for a problem.

There are three main choices you can make about points and lender credits:

You can decide you don’t want to pay or receive points at all.

You can pay points in exchange for a lower interest rate.

You can choose to have lender credits and use them to cover some of your closing costs but pay a higher rate.

Now you know - It’s not just one of these factors in particular – it’s the combination – that together determine your interest rate. Everyone’s situation is different, so by understanding these factors, you will be well on your way to shopping for the right mortgage loan – and interest rate – that is appropriate for your situation.

Source: Consumer Financial Protection Bureau (CFPB)