Once someone discovers I am in the mortgage business, the first question I hear is, “what are your rates?”
When you ask a loan officer this question, it’s the equivalent of randomly calling doctors and asking them, “am I overweight?” Knowing if your weight is ideal for you depends on your age, height, family history, exercise regime, eating habits, and other health issues. Similarly, mortgage rates also depend on many factors and fluctuate depending on your current behavior and where you are on a risk assessment determined by lenders.
Here are the six common factors that impact your mortgage rate.
Before diving into how rates vary from one borrower to the next, let’s establish why they differ. Mortgage bankers analyze data on thousands of loans in their portfolios to see how they perform. Anytime a mortgage payment is missed or a home foreclosed upon, they are studied to determine what factors may have impacted the missed payments. It all comes down to a borrower’s ability to repay and the likelihood they will walk away from their obligation to pay. Some risks do not impact rates very much, while others have a significant effect.
The Property’s Type and Purpose Might Influence The Likelihood of Repayment
What is your purpose for the home? Is it where you will live full-time, or is it a second home or investment property? If a person owns two homes and falls on hard times and can only make one house payment, they will most likely make the one that provides their everyday shelter and let the “nice-to-have-home” default. After this happens enough times, a lender can predict that a primary home is a less risky loan than a second home or an investment property. Therefore, a primary residence mortgage will price better than an investment property. Single-family residences are also less risky than condominiums or manufactured homes. So much so that some lenders will not lend on certain property types.
Loan Type and Product Choice Are Major Drivers of Mortgage Rates
The mortgage product choices impact your rate significantly. Government-sponsored loans like FHA, VA, and USDA are government-insured – and Conventional loans are government-sponsored loans meaning the U.S. government shares in the risk so lenders can lend money confidently. Loans made without the U.S. government’s insurance rely on private investors and wall street capital. Private money is less tolerant of risk, and therefore, the rates usually start one to two percent higher than conventional and government loans.
A Loan’s Term Length Can Be a Factor That Indicates Risk
The longer you borrow the money, the higher the risk. So loans fixed for 15 or 20 years will usually be lower than a loan for 30 years. However, the monthly payment is higher on a 15- or 20-year loan which brings a new set of risks. If your required monthly payment is higher, we go back to evaluate the ability of the borrower to repay the loan. (This is a decision determined during loan underwriting.)
Your Debt-to-Income Ratio Helps Lenders Determine Your Financial Resilience
The Debt-to-Income ratio is: the amount of money you owe each month (your debts) divided by how much money you earn a month (your income.) The answer is a percentage that is one of the more common risk factors a lender can measure.
Historically, if you get above 42-45% of your monthly income going directly out the door to debts, you don’t have enough cash available for an emergency such as needing a new roof or a new car. The debt-to-income ratio doesn’t account for money you have in savings, although those funds are undoubtedly valuable in determining your repayment ability if you incurred new debt.
The Debt-to-Income calculation isn’t a stand-alone rule. But it is an easy one for you to visualize why it is one of the determining factors. I find it helpful to do this equation with my take-home pay. A lender looks at your gross pay. If you want to be honest with yourself on what you can afford, use your actual income after taxes and such are deducted. That is a more realistic view of what cash you have in hand after you pay your bills.
Your Credit History and FICO Score are Critical to Determining Your Mortgage Rate
In 1956, engineer Bill Fair teamed up with mathematician Earl Isaac to create Fair, Isaac, and Company, to create a standardized, impartial credit scoring system that has evolved to become what we know as a credit score or FICO score. It impacts everything from your credit card rates to your insurance rates. Sometimes, especially if you work in the financial industry, it can be pulled as part of hiring. It is the same for your mortgage.
Those with FICO scores of 740+ will see better rates than someone in the 620-720 range. Most lenders will not lend on loans lower than 580. If you want the best interest rate you can get, visit a mortgage broker at least 60 days before you wish to purchase or refinance your home. A mortgage broker can pull your credit and determine how your FICO score impacts the rates they’re quoting. Often, they can advise you on what it takes to improve your score. If you cannot wait 60-90 days for your score to improve, it is even more critical to seek a mortgage broker. They can shop for many different lenders and find the right loan for your current situation.
Home Equity Is A Key Driver of Rates in Refinance and New Home Scenarios
In a refinance scenario, your equity is the current value of your house minus the amount you owe on your mortgage.
If you are purchasing a home, it is determined to be the amount of the down payment in cash versus borrowing in the loan. The more of your money invested in the property, the lower the risk is to the lender. Sometimes this creates a myth that you need 20% equity to get a loan at a reasonable rate. That isn’t necessarily true.
Twenty percent down might catch you a better rate, but if it makes you cash poor and sitting in a new house with no furniture, was it worth depleting your savings? You can find loan programs that range from no money down (FHA and VA loans.) 3%, 5%, 10%, and 20+%. A mortgage broker can recommend precisely how much money you should put down to meet your needs.
A Mortgage Broker Can Help You Understand Your Rates and Find the Right Loan For You
Mortgage brokers are experts when it comes to helping you get the right loan. That includes finding a low rate, but also one that works for your current financial picture.
Find a local broker you trust can talk through your current financial situation, as well as your past and goals for the future, including home buying or refinancing ideas you have. Touch base with your loan officer periodically and allow them to hear your current goals, and share plans to buy bigger or downsize your home in the coming years. Or, if you have increased debt or want to make home improvements, call them before you act. They can advise you on the best use of your cash and your home’s equity.
And try not to determine the worthiness of your mortgage broker only by the interest rates they may advertise. They have a lot more to offer.