Your mortgage rate is influenced by various factors, some under your control and others not. Understanding these factors can boost your confidence in securing a competitive interest rate from a mortgage lender.
Factors that influence mortgage rates and are within your control
Mortgage rates are adjusted by lenders based on the perceived risk of the loan. A riskier loan typically carries a higher interest rate. When assessing risk, lenders consider the likelihood of missed or defaulted payments, as well as the potential loss in the event of loan default. The primary factors taken into account are credit score and loan-to-value ratio.
Your Credit score
Borrowers with credit scores of 740 or higher typically qualify for the lowest mortgage rates and have access to a wide range of loan products. Those with credit scores ranging from 700 to 739 may encounter slightly higher interest rates, while individuals with scores between 620 and 699 could face even higher rates and potential challenges in securing sizable jumbo loans. For borrowers with scores below 620, interest rates are significantly higher, and available options are limited, with most loans being government-insured or guaranteed.
The Loan-To-Value (LTV) Ratio
LTV assesses the mortgage amount in relation to the home’s price or value. For example, if you make a $20,000 down payment on a $100,000 house, the mortgage will be $80,000, resulting in an 80% loan-to-value ratio. A larger down payment leads to a smaller loan-to-value ratio, while a smaller down payment results in a larger loan-to-value ratio.
A loan-to-value ratio exceeding 80% is considered high and poses a greater risk to the lender. This may lead to a higher mortgage rate, particularly when combined with a lower credit score, and typically necessitates mortgage insurance.
Other Contributing Factors
Lenders may impose higher charges for cash-out refinances, adjustable-rate mortgages, and loans on manufactured homes, condominiums, second homes, and investment properties due to the increased risk associated with these types of loans.
Factors Affecting Mortgage Rates Beyond Your Control
Mortgage rates are determined by market dynamics, fluctuating daily in response to prevailing and anticipated inflation rates, unemployment levels, and other economic indicators.
The Overall Economy
When there’s fast economic growth, higher inflation, and low unemployment, rates tend to rise. Conversely, rates tend to fall when the economy is slowing down, inflation is dropping, and the unemployment rate is rising.
Rising inflation often leads to higher interest rates, as the dollar’s purchasing power decreases with price increases. Lenders seek higher interest rates as compensation. In early 2022, as inflation accelerated, mortgage rates surged, and the Federal Reserve aggressively raised short-term rates. In 2023, inflation slowed, with the consumer price index indicating a 6.3% inflation rate in January and 3.1% in November. Mortgage rates increased through most of the year, reaching a peak in October before declining from November through early December.
Jobs: Layoffs vs Growth
During the COVID-19 pandemic, stay-at-home orders in spring 2020 led to layoffs and furloughs, triggering a recession. Mortgage rates, already low, fell even further as expected. As the economy rebounded and jobs returned, mortgage rates increased.
Additional Economic Indicators
Mortgage investors monitor various economic trends beyond inflation and employment, such as retail sales, home sales, housing starts, corporate earnings, and stock prices.
The Federal Reserve And Interest Rates
The Federal Reserve doesn’t determine mortgage rates. It adjusts short-term interest rates in response to overall economic trends. Mortgage rates fluctuate based on these economic factors. Although mortgage rates and Fed rates move independently, they typically align in direction.