As a first time home owner you may be wondering what mortgage lenders consider when they decide what interest you’ll pay on the loan. The truth is it’s not one aspect but several key areas that determine your mortgages interest rate. This article looks at each individual aspect to give you a better understanding on how the interest rate is calculated. And should afford you the opportunity to better your interest rate by improving your “odds”.
Here are 5 common factors that determine or affect your mortgage interest rate:
1. The Amount You’re Requesting
The larger the loan amount the higher the risk. Essentially a lender will be taking on more risk with a larger mortgage as opposed to a smaller one, because if the client defaults they’ll have to recover more money.
2. The Size Of Your Down Payment
The amount of money you pay upfront on the mortgage also influences its interest rate. A large down payment gives you a lower LTV (loan-to-value) ratio. Because mortgage lenders recognize that you have taken on a substantial portion of the “risk”, which in turn decreases the level of risk borne by a lender. If you opt to make a smaller down payment the likelihood of you having a higher interest rate increases.
3. Your Credit Score
When you’re applying for any kind of credit, lenders or creditors will pull your credit score. The same goes for a mortgage. You credit score is based on the borrowing history in your credit report, which summarizes the details of your financial history. If you’ve had a very turbulent financial history chances are the interest rate on your mortgage will be greater. However if you’ve maintained a good credit profile the interest rate will be lower. So it really does pay to maintain a good credit score or strive to improve your current one, especially if you’re in the market for a new home.
4. The Type Of Property You’re Purchasing
Some properties have a higher risk of default compared to others. This is determined by analyzing the historical likelihood of default on different properties. Lenders use this analysis as the reason to charge higher mortgage interest rates on potentially “risky” properties.
For example, vacation homes tend to have a higher default rate compared to single-family homes and lenders will probably charger higher interest rates for these homes.
5. The Risk You Pose
Until you’ve paid your mortgage in full the lender is exposed to some financial loss. Hence lenders try to mitigate this loss by setting higher interest rates to recover costs if a client defaults. Most of this risk will be analyzed through your credit score but some other factors can drive your default risk. Things of a more personal nature, like your job, your income, even your marital status can impact your default risk. If you’re perceived to have a higher default risk then your interest rate will increase.
All in all, different lenders offer different rates depending on their style of operation, appetite for risk, or competitiveness in the market. It’s important to search extensively for offers from different lenders so you’ll have access to the best mortgage rate.