Lots of factors determine how much interest you’ll pay over the life of your loan. See what you can do to score a lower rate and what’s outside of your control now.
Why do mortgage and refinance rates constantly change?
This number, which reflects how much you’ll pay your lender in interest for letting you borrow their money to buy or refinance your home, depends on many different factors.
While some of these are totally out of your control, other influences can be changed to help you find the lowest mortgage rate you qualify for.
Factors Influencing Mortgage Loan and Refinance Rates Outside of Your Control
These affect the general range of mortgage and refinance rates across the country:
When the labor market is strong and economic growth is high, economists anticipate people earning more money (and spending more money).
This is the ideal time for people to purchase homes so demand for mortgages skyrockets, which then means mortgage rates follow suit.
There’s only so much money lenders have to give so they make lending profitable in a high demand market by raising interest rates.
The same can be said about a weak economy where unemployment is high.
As wages and employment trend downward, there’s fewer demand for mortgages. Lenders then have to entice people with lower interest rates.
When the economy is strong, however, it may also trigger expectations of inflation.
Inflation happens when the price of goods and services rises in the economy, which also increases the cost of living, weakens the power of the dollar, and makes borrowing money a bit harder.
Since a dollar today isn’t worth what it used to be 20 or 50 years ago, nor will it remain the same in the future, lenders must take inflation into account before setting interest rates so they don’t lose money.
So when the rate of inflation is expected to rise, interest rates also jump so lenders earn a profit despite a weakening or fluctuating dollar.
The Federal Reserve tries to minimize inflation with policies to steady the buying power of the dollar and increase employment.
The Federal Reserve
The Federal Reserve, or the central bank of the United States, doesn’t set mortgage rates, but their measures indirectly influence them.
The Fed decides the rate at which they’ll lend money to banks.
So if the economy is slow and the Fed lowers interest rates for banks, you’ll find lower mortgage rates for home loans too. But if the Fed raises rates for banks, lenders then pass that extra cost onto borrowers with higher interest rates.
The Federal Reserve also buys and sells mortgage-backed securities (MBS) and Treasury bills. When the Fed buys more securities, mortgage interest rates go down; when the Fed sells more securities, interest rates rise.
That’s also why the strength of the bond market factors into mortgage rates.
The Health of the Bond Market
Since banks, investment firms, and the Fed use mortgage-backed securities as investments, lenders are only profitable when the overall bond market is doing well.
A healthy bond market makes investors less sketchy about acquiring MBS. This security helps lower mortgage and refinance rates.
But if the bond market is down, it’s harder to generate competitive MBS yields for investors. So you’ll generally see interest rates creep up to widen profit margins and make them more attractive.
While these factors that influence mortgage rates may be out of your control, you can swing the next ones in your favor if you’re smart.
Factors Affecting Mortgage Rates You Can Control
Though the economy matters in the macro sense of mortgage rates, these influences make all the difference in the specific rates lenders will offer you:
Your Credit Score
Your credit score gives lenders an inside look at your borrowing history and shows them how well you manage lines of credit.
Since lenders are essentially extending a bigger line of credit via a mortgage, they look for signs you’re trustworthy enough to pay back a home loan, like a high credit score.
Using the credit history you’ve established on your credit report, this three-digit number shows lenders:
- How many types of accounts you have (like credit cards, student loans, car leases, etc.)
- Which accounts are in good standing
- How often you make payments on time
Borrowers with the highest credit scores are typically offered the lowest interest rates. Lenders want their business because it means lower risks for them.
Similarly, borrowers with low credit scores are often seen as riskier. They will face higher interest charges because lenders will worry about them paying their mortgage late, or defaulting on their loan completely.
Larger home loans also mean greater risks for lenders. And that reflects in your home loan’s interest rate.
Your Loan Amount
Asking a lender to approve a home for $900,000 carries more risk and liabilities than approving one for $200,000.
To put this in perspective, you’d probably have no trouble lending a friend $20 even if they never repaid you. But you’d be a little more cautious (and upset) to loan $2,000 and never see that money again.
So that’s why interest rates typically get steeper as the total of your loan amount, or how much you’ll need to borrow from a lender, increases.
One way to lower your loan amount and see potentially lower interest rates is to save up a bigger down payment.
Your Down Payment or Equity
When you take out a home loan, you’ll put down a bit of your own money as a down payment.
This not only lowers the amount you’ll need to borrow from a lender to purchase your home, it also shows lenders you have a vested interest in the property.
Since putting down a larger down payment means you have more to lose than someone with a smaller down payment, lenders may offer lower interest rates in exchange for this lower risk.
Save up at least 20% of your home’s selling price as a down payment and lower rates will be offered your way.
If you’re looking to refinance your home, higher equity also means lower refi rates.
As long as your home’s market value is significantly higher than what you currently owe on your mortgage, you should qualify for lower interest rates as well.
The type of home loan and the type of interest you’ll be charged also affect mortgage rates.
The Type of Loan and the Type of Interest
Lenders can offer conventional, FHA, USDA, and VA loans, and each type of loan will have different requirements for down payments and interest rates. So the type of home loan you choose could carry higher or lower mortgage rates than others.
Additionally, interest rates vary between a fixed rate mortgage and one with an adjustable rate.
Fixed interest rates never change; the interest rate you pay on day one of your mortgage is the same as the interest rate you’ll be charged on your last day.
An adjustable rate mortgage (ARM), however, begins with a low introductory interest rate for a set period of time. After that time, the interest rate adjusts based on the market. This means your payments may be higher or lower each month.
Interest rates also vary based on how long you plan to pay off your mortgage.
Your Loan Term, or Duration
Longer mortgage terms usually correlate with lower interest rates and lower monthly payments.
The bad news is the longer your term, the longer you’ll be paying interest.
Shorter terms may mean higher monthly payments, but you’ll also be paying less interest over the life of your mortgage.
So an interest rate for a 30-year mortgage might be lower than one for a 15-year mortgage, but you’re also paying interest for double the amount of time.
This means despite a higher interest rate, you may actually save money by going with a shorter term.
Another way to save money (and find a lower interest rate) is by shopping around for a mortgage and comparing home loans from multiple lenders.
Operating Expenses for Individual Lenders and Banks
Big banks and large lending institutions have to earn enough money to pay for their costs of doing business. So that means the interest charged on your home loan goes to paying overhead, employee bonuses, corporate retreats, and so forth.
Smaller neighborhood lenders and credit unions often have lower operating expenses so they don’t need to charge high interest rates to cover their expenses and still earn a profit.
This is why mortgage loan and refinance rates vary between lenders and it pays to compare multiple home loans before you start house hunting.
While you can’t control how each lender does business, you can choose which one to borrow from.
If you improve the factors most impactful on mortgage interest rates, the ones outside of your control won’t matter as much.
How to Positively Influence Factors Affecting Mortgage Rates
While you may not be able to control economic growth and inflation, you can make yourself more attractive to lenders so they compete for your business.
Super low mortgage rates you see advertised are only offered to the best borrowers.
You can be part of that elite club if you raise your credit score, save up enough for a 20% down payment, clean up your debt-to-income ratio, and compare different loan types and terms.