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Mortgage interest rates are determined by a combination of factors outside of your control and factors you can control. The stronger the U.S. economy is, the higher mortgage interest rates will be overall. Lenders will offer you lower interest rates if you have a good credit score or a larger down payment.
Factors that affect mortgage interest rates range from things you have some control over, like your credit score, to larger macroeconomic trends and world events that impact your overall borrowing costs.
All of these factors play a role in determining how much interest you pay on your monthly mortgage payment. Wondering how mortgage interest rates are determined? Let's take a look at some of the main factors that can affect how lenders set your mortgage interest rate.
Quick tip: Mortgage interest rates depend on market conditions, such as the overall economic outlook, as well as individual factors like your credit score, how you'll use the property, and the size of your down payment.
External factors affecting mortgage rates
1. Economy
If you're having trouble understanding the fluctuations in mortgage rates and what's causing them, look to the economy.
Mortgage interest rates tend to be higher in good economic times and lower in bad times. For example, interest rates plummeted in 2020 as the COVID-19 pandemic battered the U.S. economy.
Inflation can have a big impact on mortgage interest rates. As inflation rises, mortgage interest rates tend to rise as well.
2. Federal Funds Rate
The federal funds rate is the interest rate that banks charge to lend to each other and is set by the Federal Reserve Bank. The Federal Reserve rate affects interest rates on credit cards, loans, savings accounts, and mortgages.
The Fed has an indirect effect on mortgage rates, meaning that mortgage rates don't directly track the federal funds rate. However, the federal funds rate does have some influence and can be an indicator of the overall state of the economy — the higher the interest rates, the better the economy is doing. So by keeping an eye on the Fed's interest rates, you can get an idea of which direction mortgage rates are headed.
Personal Factors You Can Control
1. Credit score
Your credit score is a number that represents how risky you are as a borrower. A higher credit score indicates you're more likely to pay back your loan because you pay your bills on time and have a history of borrowing (and paying back).
Credit scores range from 300 to 850. According to the FICO model, here's how your score breaks down:
Poor: 300 – 579Average: 580 – 669Good: 670 – 739Very Good: 740 – 799Excellent: 800 – 850
For example, your interest rate probably won't change much (or at all) if your score goes from 710 to 720. But if your score goes from “fair” to “good” or from “good” to “very good,” a lender will likely offer you a better rate.
2. Debt-to-income ratio
Your debt-to-income ratio is your monthly debt payments divided by your gross monthly income. If taking out a mortgage means taking on more debt and owing so much money that you'll have a hard time paying it off, lenders will see you as a riskier borrower and charge you a higher interest rate.
The lower your DTI ratio, the better. Minimum DTI ratios vary depending on the lender and the type of mortgage you get, but they typically range from 36% to 50%. If your ratio is even lower than your lender's minimum, you may be able to get a better interest rate.
3. Down payment amount
The minimum down payment required depends on the type of mortgage you take out. Some loans, such as VA loans and USDA loans, require a 0% down payment. Conforming loans require a minimum down payment of 3%. Some lenders may require a higher down payment depending on the type of loan you take out.
If you can make a down payment that's more than the minimum, lenders will likely reward you with a better interest rate.
For example, lenders have a minimum down payment of 3% for a conforming mortgage. A 10% down payment will likely lower your interest rate, and a 20% down payment will lower your interest rate even more.
4. Types of mortgages
Interest rates vary depending on the type of mortgage you take out. Here's what you can expect to pay:
Conforming Mortgages: This is what you probably think of as a “regular mortgage.” These interest rates may be higher than those for government-guaranteed mortgages, but lower than those for jumbo mortgages. Jumbo Mortgages: These are mortgages for amounts that exceed the conforming loan limit. Because they are riskier, they usually have higher interest rates. Government-Guaranteed Mortgages: FHA, VA, and USDA loans have some of the lowest interest rates for those who qualify. These mortgages are guaranteed by a federal agency, which compensates the lender if you default on your payments. Government-guaranteed mortgages tend to have the lowest interest rates because they are the least risky for lenders.
The amount you pay may also increase depending on whether you are taking out a mortgage on a primary residence or an investment property. The riskier the loan, the more you will pay.
5. Mortgage term
When you take out a mortgage, you usually have at least two or three options for how long you want your loan to last: The shorter the mortgage term, the lower the interest rate.
For example, the interest rate on a 15-year mortgage will be lower than the interest rate on a 30-year mortgage.
Keep in mind that a shorter term means you're paying off the same loan principal in a shorter period of time, so your monthly payments will be higher. But in the long run, you'll save money through a lower interest rate. You can use a mortgage calculator to see how different term lengths and mortgage interest rates affect your monthly payments.
How to get the best mortgage rate
Addressing the things you can control
You can't control whether the economy is struggling or booming. Of the factors that are technically controllable, not all are within your reach. For example, you might not be willing to take out a lower interest rate and shorter term mortgage because your monthly payments are too high for your budget.
But you may be able to pay down some of your credit card debt, which will likely lower your debt-to-income ratio and improve your credit score, both of which can help lower your interest rate.
Find a Lender
Different mortgage lenders charge different interest rates, so comparing quotes from multiple mortgage lenders will help you get the best terms.
If you're still early in the process, you could call around to see what interest rates lenders are offering, or even get pre-approved for a mortgage with a few lenders to get quotes based on your financial situation and credit score. Keep in mind, though, that doing this will likely result in the lender running a hard credit check, which will show up on your credit report and could temporarily lower your score.
How are mortgage interest rates determined? Frequently asked questions
Mortgage interest rates are affected by a variety of key factors, including inflation, monetary policy set by the Federal Reserve, and bond market conditions.
A larger down payment reduces the amount you borrow against the value of the home, keeping your loan-to-value ratio low. Lenders prefer lower LTV ratios because they represent less risk, so people who make a larger down payment often qualify for more favorable mortgage interest rates.
Fixed mortgage rates aren't tied to the 10-year Treasury bond, but they attract the same types of investors and so typically track that yield, while ARM mortgage rates are based on a linked index, such as the Secured Overnight Financing Rate (SOFR).
Laura Grace Tarpley, CEPF
Editor, Personal Finance Review
Molly Grace
Mortgage Reporter
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