There’s one question that we get a lot here at Better Home Financial. The one question that everyone close to us wants to know the answer to. And, of course, who can blame them?
Its answer is the mast by which the mortgage industry sails after all, dictating the behaviors of home owners and mortgage professionals alike.
"So, what's the rate?"
Like most simple questions, there's hardly ever a simple answer.
But to skip to the part where you find out what your interest rate would be today, feel free to use our FREE Mortgage Rates Quoter to get started.
You see, there are many factors that go into someone's individual mortgage interest rate. But, as with any interest rate, all the factors have one common theme: RISK. Understanding risk is the first step to understanding mortgage rates, and in fact, the entire finance industry!
Luckily, since all mortgages are backed by the value of the home, mortgage rates tend to stay far lower than any other types of debt like credit card debt, or business loans. Because the home is acting as a fair collateral for the loan, mortgages are a lot less risky for a lender compared to other loans.
If a borrower fails to pay back their loan, the lender can always sell the house and recoup a large percentage, if not all, of their money back.
So, fortunately for people seeking mortgage loans, mortgage rates tend to stay relatively low overtime.
With all that said, there are a few other factors that go into determining your personally tailored interest rate, but they ALL have to do with how "RISKY" the lender perceives you to be.
Let's go over the 5 most important factors that determine your mortgage rate: 1.) Credit Score, 2.) Loan to Value Ratio, the 3.) Type of Property being purchased, if the property will be 4.) Owner-Occupied, and finally 5.) Macroeconomic factors.
1.) CREDIT SCORE
Your credit score is one of the most important factors to deciding whether your interest rate will be 3% or 6%.
A good credit score is a lender’s first indication of how well you have handled debt in the past, how much experience in general you have with debt, and how healthy your level of debt is compared to your income.
With a good credit history, lenders perceive the borrower to have far less risk in regards to making their mortgage payments on time. The best thing to do when looking to purchase a home or refinance is know what your credit score is.
If you’re wondering how, you can get a soft check of your credit for free at websites like creditkarma.com. A good credit score is above generally considered to be above 670, so if yours is below this threshold it may be a good idea to see if there are any errors on your credit report.
Sometimes credit agencies receive information that is false and may be reconciled, thereby instantly increasing your score and potentially saving you THOUSANDS on your mortgage. For the best mortgage rate, aim to get your credit score up to 750 if at all possible!
Luckily, the experts here at Better Home Financial specialize in finding the perfect mortgage solution for your specific credit situation. This is where our experience and relationships with lenders play a crucial role for our clients, for not all lenders offer the same rate even given the same credit score information, and we make it our mission to find you the absolute lowest rate possible.
However, if you’re looking for more information on how to increase your credit score check out this handy article from guys over at Nerd Wallet, which you can find here.
2.) LOAN TO VALUE
The second factor that determines your interest rate on your home mortgage is the loan amount you are looking to borrow versus the value of the property you are purchasing. This is called the Loan to Value ratio.
For an easy example, say you are looking to purchase a $100,000 house and need a $80,000 loan to help cover the cost. Your loan to Value would then be $80,000 to $100,000, or 8/10, or 80%. The lower you can get your loan to value ratio the lower your interest rate will be! As a home buyer, this means saving more money you put towards your down payment, thereby decreasing the amount of money you need to borrow, and decreasing your loan to value ratio.
If you are refinancing, the principle is the same. But in this situation, the HIGHER the amount of equity you have built up compared to the current value of your home, the better!
Equity is just another way of describing how much of your home you actually own compared to your lender. If you want to learn more about how this works, we will be releasing another article soon to explain further.
The short story is that generally the longer you have owned your home and made mortgage payments, the more equity you have in your home!
So why does Loan to Value matter to a lender anyway? As we discussed before, it all comes down to risk. If you own more of your home, then the lender isn’t exposed to as much risk when it comes to the fluctuation of housing prices. Why does this matter?
Let’s say a borrower is unable to repay their mortgage at some point, so the lender assumes ownership of the home in order to recoup the money they leant. To use our previous example, if the Lender only had to lend 80% of the home’s value, then the lender only needs to sell that home for $80,000 to recoup the entire loan amount.
This buffer between the market value of the home and the outstanding loan amount on the home acts as a kind of shield between the lender and possible fluctuations in the housing market that might bring housing prices down.
Imagine if a lender funded 100% of the purchase of a home, the borrower defaults, and the house drops $20,000 in value! The lender would suffer huge losses, and this is a situation lenders try to avoid at all costs so they can stay in business.
The higher this buffer is between what the lender has given and what the market value of the house is, the less risky your loan is perceived to be.
So to recap, the LOWER your loan to value is, the BETTER!
3.) TYPE OF PROPERTY
Another factor that a lender will take into account is which type of property you are trying to purchase with your mortgage. If you are purchasing a traditional single family home in San Dimas where you will be owning the house and the land, or a planned unit development (PUD) such as a town home or a home in a gated community, then your rate will be lower!
If you are purchasing a condo in however, your rate will be slightly higher by default. This is because with a condo you only own the space within the walls of the condominium, and technically only own a small percentage of the land that the condominium complex sits on.
In contrast, with a single-family home or PUD you not only own the home but also a plot of land that the home sits on, thereby making the property more valuable.
As with the other factors, the discrepancy between interest rates of these types of properties comes down to risk. If you own a piece of land and a home, there is far less risk for a couple reasons.
There is more utility, or things you can do, with the land the house sits on when compared to simply owning a part of a large building and a fraction of the land, as is the case with condos. Also, if something happens to the condominium complex, such as a natural disaster tearing it down, then you’re not left with much value afterwards.
Compare this same situation to a single-family home, and even if a tornado pulled the home from the ground, you’d at least still own the land!
Therefore, lenders perceive owning single family homes and PUDs as being less risky than other types of housing, and thus charge a lower interest rate on mortgages for said homes.
This introduces yet another way the pros at Better Home Financial make a difference for our customers. By knowing which lenders are more generous to your individual mortgage situation and type of property you are looking to buy, we can find you the best possible mortgage solution.
4.) OWNER OCCUPIED VS NON-OWNER OCCUPIED
One of the last factors that determines what your interest rate on your home mortgage will be is whether the home you are buying will be your primary living home.
As in most cases, when a borrower is looking to purchase a home, it will be the one where they live, so their interest rate is unaffected by this factor.
But let’s say you already own a home in San Dimas, but are getting a mortgage to purchase a second home, such as a vacation home in Hawaii! A lender may charge just a slightly higher rate for your mortgage because, statistically speaking, these houses are a little riskier to lend to.
Why is this? In times of financial hardship, a borrower is much more likely to continue paying mortgage payments to their primary residence where they live, rather than their second home which can be considered more of a luxury than a necessity.
This fact increases the default risk of “non-primary” homes, and thereby justifies the slightly higher interest rates for these kinds of mortgages.
Now let’s say you want to buy a house in San Dimas so you can rent it out and make a return on your investment. In this case, your interest rate will be even higher than a second home, since you are purchasing a property simply as an investment without any intention of living in it.
Lenders then know you may be relying on your tenants to make your mortgage payments, making these properties default risks even higher.
What if you can’t find a tenant? What if they stop paying rent? These are questions the lender asks themselves.
Also, you run into the similar problem as a second home: if this isn’t your primary residence, or just simply an investment you don’t have any other use for, then you are far more likely to default on that mortgage as compared to the home you live in every day.
The final factor that will dictate your interest rate is the overall macroeconomic climate, or in other words, the economic conditions of the country (or even world) during the time you decide to get a mortgage.
This is a factor, unlike the others, that is completely out of your control. So, on the one hand, don’t sweat it! But it is good to understand that macroeconomics can play a big factor in the interest rate you receive. If you look at interest rates in the early 1980s for example, the general level of interest rates for savings accounts was 16%, meaning your home mortgage would likely be even higher than that.
In today’s macroeconomic environment, this level of interest rates sounds absurd, but is just a testament to impact macroeconomics can have on your individual mortgage rate. And it doesn’t always take years for rates to make a noticeable change, there are small monthly, weekly, even daily fluctuations in interest rates as market forces influence them.
By now you probably have a much better understanding about what determines your interest rate.
With an understanding of how Credit Score, Loan to Value, Type of Property, Owner Occupied Properties, and Macroeconomic conditions affect your interest rate, you will be better prepared when finding a mortgage broker to help you find the optimal lender for you!
But you should also understand that with the many factors that go into how expensive your home mortgage can be, it is crucial to have someone on your team that has the experience, reputation, and drive that you can trust will find the best solution for you given all possible scenarios.
Better Home Financial takes pride in being that team for so many in the San Dimas area, and we’re confident our unparalleled expertise will earn your business.
If you find yourself with the burning question, “What’s my interest rate?”, we’d love to give you an answer!
Click or call us to set up an appointment so we can answer any of the questions you may have, and give you the confidence that you and your family will be fully taken care of.