How Mortgage Rates Work?

When shopping for a home, buyers aren’t only interested in getting the best sales price, they’re also interested in getting the lowest mortgage rate.

But although rates play a major role in getting a mortgage, you might not fully understand how mortgage rates work, as well as factors that influence rates.

Mortgage rates can fluctuate from year-to-year, and this causes some people postpone buying or refinancing a home until rates are low. Here’s what you need to know about mortgage rates, plus tips on how to get a favorable one.

How Mortgage Rates Affect Payments

A mortgage rate reflects the interest a lender charges for a home loan. These charges are included in the home loan payment, which is then paid on a monthly basis for the duration of the mortgage loan. The portion of the home loan payment that is applied towards interest charges changes over the course of the loan. In the early years of a mortgage, the majority of a payment goes towards paying interest. At the end of the loan term, most of the payment goes towards paying back the principal.

Mortgage rates can be either fixed, meaning your rate stays the same over the life of the loan. Or you can have an adjustable-rate mortgage (ARM), meaning you’ll have a fixed rate for a certain period of time followed by periodic rate adjustments. For example, if you have a 5/1 ARM, you’ll pay a fixed rate for the first five years of your mortgage, and then your rate will begin adjusting based on the terms of your loan

How Are Mortgage Rates Determined?

Even though mortgage lenders create loans and provide applicants with rate quotes, lenders don’t determine whether rates increase or decrease. Rather, investors who invest in mortgage-backed securities drive the direction of rates.

It’s important to understand that when some lenders originate mortgage loans, they don’t usually retain these loans in their portfolio. Instead, they sell these mortgages to third-parties such as Fannie Mae and Freddie Mac, who then package these loans into mortgage-backed securities to be sold to investors. Simply put, the price that investors are willing to pay for these securities influence mortgage rates.

One misconception is that the Federal Reserve—America’s central bank—decides mortgage interest rates. Therefore, some might assume that when the Fed cuts the federal funds rate, mortgage rates also go down. However, when the Fed decides to raise or reduce rates, this mostly affects short-term or variable rates. That being said, adjustable-rate mortgages might increase or decrease, but there might be little impact on fixed-rate mortgages.

How to Get a Good Mortgage Rate

Along with understanding how mortgage rates work, you also need to understand how to get the best rate possible. A low-interest rate can reduce your mortgage payment, increase your purchasing power, and reduce the overall cost of your loan.

Different factors determine your individual rates, such as your credit score, debts, and the size of your down payment. Having a good credit score is one of the biggest factors that influence rates.

Read our blog on "How Credit Score can affect your Mortgage Rate".

Therefore, pay your bills on time, keep your credit card balances low (less than 30% of your credit limit), and pay down other debt. Aim for a credit score of at least 700 or higher. Additionally, many mortgages require a minimum down payment of 3.5% to 5%; however, a larger down payment may help you negotiate a better mortgage rate, so be sure to check with your lender about the options available.

Final Word

Whether you’re thinking about buying or refinancing, a low mortgage rate can save you money while increasing your buying power. The home loan experts at Blue Spot Home Loans can provide you with a free rate quote. Call today or fill out the contact form to get started.