What Is a Mortgage Rate?
When you take out a mortgage, the mortgage rate is the interest rate you are charged. Unlike regular loans, mortgage rates can be fixed at a certain rate, or the rate can vary based on market prices. What type of rate you get depends on whether you have a fixed, adjustable, or variable mortgage.
When it comes to Islamic home financing, it is important to note that you are not getting a loan. However, Islamic home financiers typically benchmark their rates with the prevailing mortgage rates in the United States. This is done partly to make it easy for consumers to comparison shop as they look for the right home financing. It is not riba, as no loan is involved.
How Mortgage Rates Are Determined
To determine the mortgage rate you will receive, there are a number of factors to consider that can increase or decrease your rate. This includes:
- Credit Score. The biggest risk lenders take is lending money out. They want to make sure that you can afford the house you are buying. Your credit score will determine how much of a risk you are. The higher the score, the lower the rate.
- Loan-To-Value Ratio. Your LTV ratio is how much the loan is going to be for versus how much the value of the home in question is. Opting for a more affordable home is a good way to make this more loan-friendly.
- Federal Rates. Federal rates are based on the economy and inflation. If we have a major depression, the rates drop. This is not within your control, but it can change the rate you receive.
Types of Mortgage Rates
It’s important to understand that your mortgage rate will dictate a large part of how much you pay. It’s also the main part of your APR, which totals the interest that you pay along with any fees that you may have to pay on top of that.
These are the types of mortgages that you may encounter and how their rates differ.
1. Fixed
A fixed mortgage will have the same mortgage rate throughout the entirety of the loan.
Pros:
- This makes your monthly bills more predictable, which is important if you want stability in your payments.
Cons:
- If mortgage rates shrink, you might miss out on a way to save money.
- They also can be higher than other mortgage rates.
- You may have to strategize in order to get the lowest interest rates possible.
2. Adjustable
An adjustable-rate mortgage, or ARM, is a mortgage loan that starts with a low rate and then periodically adjusts to the market’s value.
Pros:
- Your mortgage rate can go down if the market is down.
- You start off with a lower mortgage rate that can last for years.
Cons:
- It’s unpredictable and can easily turn a home unaffordable if it has no rate cap.
- You can’t plan ahead as easily with an ARM.
- When it goes up, it can go up pretty steeply.
3. Variable
Variable rate mortgages will be adjusted and changed, just like ARMs. The difference is how frequently they change and the specific terms.
Pros:
- Your mortgage rate can go down if the market is down.
- You start off with a lower mortgage rate that can last for years.
Cons:
- It’s unpredictable.
- You may need to pay more than your home’s principal.
What Is APR?
APR stands for annual percentage rate, and it’s very similar to your mortgage interest rate. Both allude to interest, but the truth is that they are different. The mortgage rate is the bare-bones interest rate that is going to be tacked onto you loan.
APR is always a bit higher. This is the total amount of extra interest and fees that are tacked onto your loan. So, it’s your mortgage rate along with the fees involved.
5 factors that affect your mortgage rates
Mortgage payments are comprised of two parts: Principal and interest payments.
The principal is the part of your payment that goes directly toward your balance, while the interest is the cost of borrowing the money. Your home loan balance and mortgage interest rate determine your monthly payment.
Mortgage rates can vary widely from one borrower to the next. A mortgage loan company can help you compare rates, fees and offers – just click on what you’re looking for and they’ll do the rest.
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Mortgage lenders base interest rates on a slew of factors, including:
- Credit score: Generally speaking, the higher your credit score, the better your mortgage rate. Lenders typically reserve their lowest rates for borrowers with 740 credit scores or better, documents from mortgage giant Fannie Mae show.
- Down payment: A larger down payment means the lender has less money on the line. Lenders typically reward a sizeable down payment with a lower interest rate. Small down payments are riskier and come with higher rates.
- Loan program: There are many types of mortgage loans, and some offer lower rates than others. A VA loan, for example, typically has the lowest interest rate, though they’re only available to veterans, military service members and surviving spouses. With an FHA loan, you can have a lower down payment and credit score but it’s only available to first-time homebuyers.
- Loan type: You can choose a fixed-rate mortgage or an adjustable-rate mortgage. With adjustable-rate loans, your interest rate is low initially but can rise over time. Fixed-rate mortgages usually have slightly higher rates, but they’re consistent for the entire loan term.
- Loan term: Mortgages come in various terms – or lengths. A short-term loan tends to have a lower interest rate than a long-term home loan. For example, in 2021, the annual average interest rate on a 30-year fixed rate was 2.96%, and 2.27% on 15-year loans, according to Freddie Mac.
The economy and each mortgage lender’s overhead costs, appetite for risk, and capacity will also play a role. A lender with lower overhead costs can typically offer a lower rate. These factors mean that it is essential to shop for several lenders when applying for a mortgage loan. Freddie Mac estimates that getting at least five quotes can save you up to $3,000 over the life of your loan.
How to calculate how much interest you’ll pay on a mortgage
Mortgage interest is calculated in arrears – meaning for the month before your payment date. When applying for a mortgage loan, your lender should give you an amortization schedule, which breaks down just how much you’ll pay in principal and interest for each month of your loan term.
At the start of your loan, more of your payment will go toward interest. You’ll pay more toward your principal balance as you get further into your term.
What can cause your interest rate to change?
If you get an adjustable-rate mortgage (ARM), your interest rate and monthly payment can change.
With these loans, your interest rate is set for an initial period of three, five, seven or ten years. After that runs out, your rate rises or falls based on the market index it’s tied to.
Adjustable-rate mortgage loans typically come with rate caps, limiting how much your rate can increase initially, annually and over the life of your loan. These caps can vary by lender, so it’s important to compare a few different companies if you’re considering an adjustable-rate mortgage.
The Federal Open Market Committee sets the short-term interest rate – the federal fund rate – that banks use to borrow money. The federal fund rate doesn’t directly affect long-term rates such as mortgages, but the two tend to move in the same direction.
How to determine your monthly payment
To determine your mortgage rate and monthly payment, you’ll need to get pre-approval from a mortgage lender. They will pull your credit score and ask for details regarding your finances and home purchase.
Within a few days, you’ll receive a loan estimate, which will break down your estimated loan amount, mortgage rate, monthly payment and other costs that come with the loan. You can use this form to compare quotes across multiple lenders and ensure you get the best deal.
Consider mortgage refinancing
If you ultimately don’t like the mortgage interest rate you receive – or decide you want to pay your mortgage down quicker than the initial 30-year time frame – then mortgage refinancing is worth considering.
This is when you take out a new loan to replace your existing one, usually at a lower interest rate and at an adjusted (shorter) length of time. Mortgage refinance rates were at historic lows in recent years. While they have edged up since the start of the pandemic they’re still low enough that it could make financial sense to pursue. This could potentially save you both time and money. It’s an effective way to lower your rate without doing any damage to your credit score.
Talk to a mortgage refinance expert today and see if it makes sense for you.
