How Mortgage Interest Rates Work

We all want the lowest interest rate possible. How are interest rates determined?

Whether shopping for a credit card or an auto loan, everyone is trying to get the best available interest rate. This is especially true when shopping for a home mortgage. Buying a home is the largest transaction many people will make in their lives. Because of this, the smallest differences in rates translate to a lot of money spent or saved.

Katherine Levonja, Business Development Manager at Lyons Mortgage, says interest rate questions are the most frequent queries she receives. She elaborated:

“The market plays a big role in the fluctuation of the interest rate but there are many other compensating factors as well. One factor is whether you are refinancing or purchasing a primary or investment property.”

“If it is a refinance, whether you are cashing out or doing a rate-term refinance makes a difference. If you’re buying, it depends on if it is a primary or investment property, multi or single-family unit. A credit score above 740 will help you receive the most competitive interest rate. If your score is lower, it’s reflected in the rate.ā€

ā€œConsider the loan-to-value ratio, too. Are you making a significant down payment to buy the property? Do you have significant equity in the property for which you’re refinancing the existing mortgage? The more details you give your loan originator, the more accurate they can quote an interest rate for you. Every scenario is unique.ā€

Other factors: Loan term

Monthly mortgage payments are higher for 15-year mortgages compared to 30-year mortgages. However, shorter loan terms carry lower interest rates. Not only are they cheaper to originate but because the loan is being paid off quicker. These factors make 15-year mortgages less risky. This extra safety results in a lower interest rate.

See the differences in rates between 15-year mortgages and 30-year mortgages here.

The Federal Reserve

Stephen Casil has spent much time detailing the Federal Reserve’s influence on interest rates in his Casil Reports. In early 2020, the Federal Reserve started purchasing massive amounts of mortgage-backed securities. Why? The Fed wanted to help stimulate the American economy amidst economic uncertainty. By buying these MBSs, they provide liquidity to the market, reducing costs for both consumers and lending institutions. In strong economic circumstances, the Fed will raise interest rates to keep inflation small.

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