What is a Mortgage Rate?
A mortgage rate is the rate of interest charged on by a mortgage lender.
Mortgage interest is included in a home loan’s monthly payment. As you pay off the loan, you pay down the money your borrowed, so the interest portion of each payment you make is likely to decline.
Mortgage interest rates come in two types: fixed and variable.
Fixed Rate Mortgages
If the interest rate is fixed, the annual percentage rate (also called the APR) won’t change during the repayment period.
In recent years, interest rates have been very low by historic measures. Fixed rate mortgages with interest of less than 4% a year have been very common. If you consider that, and the likelihood that interest rates can only go up from here, getting a loan that locks in a rate for many years is probably a good idea.
Variable Rate Mortgages
If the rate is variable, or adjustable, meaning it can change from time to time based on pre-set conditions, your interest payment will adjust when the rate changes. Adjustable rate loans typically have lower interest rates than fixed-rate loans, at the outset. Why is this? Lenders don’t like losing money, nor do they want to limit future profits. If they believe interest rates are lower now than they might be some years from now, they won’t want to commit to a very low interest rate over several decades, so they charge higher interest for a 30-year loan than a 15-year one.
Are interest rates going up?
Since rates are at historic lows, it is projected by most experts, that mortgage rates will go up in the next 3-5 years. With this in mind, it makes sense to get a fixed-rate mortgage.
Recent History of Mortgage Interest Rates: 1980-Present
In the early 1980s, when interest rates on mortgages went as high as 18%, many buyers opted for adjustable rate mortgages. Those came with introductory rates that allowed borrowers to pay reduced interest for a set amount of time before the interest rate adjusted to a bigger percentage. In times of high interest, the appeal of adjustable rate mortgages was substantial.
Interest rates have moved lower for years. For home loans closed in February 1982, the average interest rate was of 15.37%. The average fell to 9.31% in February 1989 and continued to drop. In February 2006, the average was 6.3%. In August 2017, the average was 3.99%.
At today’s low rates, adjustable loans (also called ARMs) aren’t very popular. So when you are shopping for a loan, consider that the small amount that you might save now on an ARM might backfire if interest rates increase substantially when the loan adjusts five or seven years from now.
What is a good mortgage rate?
As a rule-of-thumb, anything under 4% APR is a good rate today.
You may not qualify for the best rates based on your credit history, debt-to-income ratio or other risk factors. But a good rate is a rate that is competitive (get at least 3 quotes) and one that results in a home payment that you can afford. If you can’t get the best interest rate on a mortgage, consider buying a lower-priced home to make up for the higher rate. You can still reap the benefits of homeownership (appreciation, paying down your loan, tax deductions, etc) with a 5-7% mortgage interest rate, as long as you keep your monthly payments at an affordable level.
How to Get the Best Mortgage Interest Rate
To get the best mortgage interest rate, you need to be classified by lenders as a low-risk borrower. Lenders use the following criteria to assess risk: credit score, downpayment, debt-to-income ratio, and income stability.
Here’s how to get the best interest rate on a mortgage:
- A credit score above 720
- A downpayment of at least 20%
- A low debt-to-income-ratio, including a mortgage payment that is 30% or less of your take-home pay
- A stable income, for example, working at the same company for 2 years or longer
- Shop multiple lenders and negotiate your rate: never accept the first rate offered you
Finding the best mortgage rate is far easier now than it once was. A plethora of web sites offer tools to compare lenders, and when you find one that looks good, you can often click on a hyperlink that takes you to the lenders loan application page.
Other Loan Costs
Mortgage interest is important, but pay attention to other loan-related fees when considering lenders. Some charge extras, often with the goal of a lower rate that saves you little if anything when the fees are included. When you investigate loans, always ask about origination fees, appraisal fees, underwriting fees, mortgage insurance and an arbitrary add-on called points. If an advertised interest rate is lower than the others, it could be the fees are higher.
These fees are negotiable. Be sure to shop around and get written quotes from multiple lenders. Ask for these additional fees to be eliminated or lowered.
Buying Points Lowers Your Mortgage Rate
Once you find a loan that sounds good, you need to dig deeper. As mentioned, some lenders charge extra fees, often called points, that drive up the upfront cost of the mortgage. Sometimes points are assessed on borrowers with less-than-great credit histories. Other times, lenders use points to lower the interest rates. By adding points, they can offer a lower interest rate and make approximately as much money as they would at the higher rate. This is a tricky practice, and you should always consider the impact of points before you agree to a mortgage loan.
The impact of points is easy to compute, since each point is 1% percent of the loan amount. If you need a $200,000 loan, a one-point fee would be $2,000 tacked on to your loan closing cost.
You can also pick a local mortgage broker to do the leg work for you. Mortgage brokers are useful in explaining the difference between loans and assessing their relative cost, factoring in points and other fees. Keep in mind that mortgage brokers earn commissions and might favor particular lenders, so ask questions before you choose one.
Subprime Interest Rates: Beware
Mortgage rates also vary based on how much money you need to borrow, your income and your credit history. Prior to the national real estate market collapse in 2008, many lenders offered subprime loans, which many experts pointed to as a scapegoat for the recession. Subprime loans were mortgages with higher interest rates than conventional mortgages offered to people with low incomes or poor credit or who simply failed to shop around and understand they qualified for better rates.
Many had adjustable rates or were interest-only mortgages, and when the rates adjusted, borrowers were unable to keep up their payments. Widespread defaults burst the housing-price bubble as foreclosed houses began flooding many markets.
When you shop for a loan, don’t forget how points and other fees figure into your loan closing cost or your payment. One lender might build fees and other costs into your mortgage rate, others might lower the mortgage rate in exchange for upfront points and fees. Fees included in an interest rate are called lender credits. Be sure to discuss how the loan is structured and understand the terms before you sign.
About The Author
Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it in 2012, helping birth Debt.org into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering the high finance world of college and professional sports for major publications, including the Associated Press, New York Times and Sports Illustrated. His interest in sports has waned some, but he is as passionate as ever about not reaching for his wallet. Bill can be reached at [email protected].
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- Pelto, T. (2013, May 30) Know Your Mortgage: Rates Explained. Retrieved from: https://www.quickenloans.com/blog/mortgage-rates-explained
- NA, ND. Mortgage Rates History 1980 Through 2016. Retrieved from: https://www.erate.com/mortgage-rates-history
- NA (2017, August 3) What Are (Discount) Points and Lender Credits and How Do They Work? Retrieved from: https://www.consumerfinance.gov/ask-cfpb/what-are-discount-points-and-lender-credits-and-how-do-they-work-en-136/