This question is asked all the time. As a matter of fact, that is typically the first question a potential borrower asks. In other words the first question that gets asked is “How much does it cost?”. Now this is a good question and it does matter, however it can be an extremely difficult question to answer without knowing all the details.
The mortgage industry is totally responsible for borrowers asking this question first because of their advertising campaigns, which by the way are very often misleading. The last financial crisis and mortgage crash exemplifies this. Mortgage companies often advertise some outrageously low interest rate knowing that most people will never qualify for that rate in order to get the phone to ring. Many unscrupulous loan officers will use this tactic for rate bait and switch. They get you into the system explaining what your payment would be at the low advertised rate. Many times, after a borrower has applied, paid fro the appraisal, paid for the home inspection and placed a deposit on the home, the borrower will get a call explaining that after their file has gone through underwriting they do not qualify for that great rate and program. The loan officer will explain they will have to switch the loan program and the rate is now higher or more costly than the borrower was originally told. Now you’re stuck unless you want to walk away from all the money you just spent. Not many people do that and they get very angry.
Let’s use another example as a parallel. Let’s say for example you wanted to purchase a car. You walk onto the car lot and the first question you ask the salesperson is how much do your cars cost? Can you imagine what his answer would be? Do you think the salesperson would say “Our cars cost $21,000.00”. Of course they would not say that and chances are you would not ask that as your first question. Typically what you would do is tell the salesperson what type of car you are looking for, what your needs are for the car, what options you would like to have and what price range you would like to shop in. These few things help the salesperson steer you in the right direction and get the conversation started. Now you can have a discussion and narrow down exactly what it is you want compared to what is available that meets your needs. It is like this with any product sold in the market place. Mortgages are no different.
Factors that determine your interest rate
The truth of the matter is you can get any interest rate the market is offering. Honestly! The better question is how much will I be charged to get that interest rate. There are many factors that go into determining the price for interest rate you want. The first and most important factor is your credit score. Your middle credit score is used to determine the price.
For example. Let’s say you have a middle credit score of 740. You want to know what the market interest rate is today on a 30 year fixed rate mortgage with 0 points. A point is a percentage fee to obtain a particular interest rate. With this credit score you are eligible for a 4.25% interest rate with 0 points today. A person with a 660 credit score would also be eligible for a 4.25% interest rate but they would be charged 2 points for this rate due to their credit score. If the 660 credit score borrower wanted a 0 point interest rate they may have to take a rate of 4.75%. So you see, the same interest rate is obtainable for either borrower but the price for the interest rate is different.
Let’s consider another factor in determining the price of an interest rate. The type of property you are purchasing or refinancing. If your transaction is for a single family detached home you may not have any pricing adjustments to your interest rate. If your transaction is for a 2 unit investment property that you do not live in, your pricing adjustment may be 2.5 points. Why the difference? It all has to do with risk. Mortgage companies have statistics that show a single family detached home has less risk of default than a non owner occupied 2 unit investment property. In other words it is less likely a borrower who gets in financial trouble will walk away from their primary residence than they would walk away from an investment property they did not live in.
An additional factor is the amount of down payment a borrower has when purchasing a property or the loan to value ratio when refinancing a property. A borrower who puts 20% down will get a better price on the interest rate than a borrower who only puts 5% down. Why? Risk. The more skin the borrower has in the game, the less likely they are to default.
In summary
Three major factors are considered when determining the interest rate you will be offered in your mortgage transaction. There are several more that have not been covered in this article that also affect the cost of your interest rate. For the purpose of article length I have not covered all of them. The better question to ask is when shopping for a mortgage is ‘What is the best way for me to structure my mortgage transaction for my specific situation and does my loan officer have the experience to provide me my best solution and price?’