The interest rate is often the most worried about component of a home mortgage. Most people base their decision on the rate they receive. Truth be told, there are many other factors to consider including the closing costs, amount of mortgage insurance, and the terms of the loan, but here we are going to take a look at the interest rate alone and what affects it. No two borrowers receive the same rate, even if they go to the same lender – there are many factors that affect the rate a lender provides you.
The Base Rate
Every loan starts with a base rate. This rate can change daily and sometimes multiple times per day, depending on how the market is that day. You have no impact on what happens to the base rate that you are provided. The only way you can control this aspect of it is to watch rates daily and wait until they hit the low you want them to hit if you are waiting for a specific rate.
The part of the interest rate that you can control is the adjustments that lenders make to your rate. Think of the interest you pay on your mortgage as the lender’s profit – they lend you a large amount of money and you pay them a small profit in order to hold that money for the next 15 to 30 years. That being said, the rate they provide you is directly related to the level of risk you pose to the bank. It’s a direct relationship – the riskier you are, the higher your interest rate and vice versa. If you do not pose a large risk, the lender does not need to worry about making as much profit as possible while you are making payments, which translates into higher interest. On the other hand, if you are risky, they will give you the highest interest rate they are allowed to in order to make some money on your loan now.
Following are the most common reasons for adjustments:
- Credit score – Every lender has a different threshold regarding the scores that they deem risky. In general, the lower your credit score, the higher your rate. This could mean a variety of different things depending on the lender you choose. Some lenders make adjustments for scores under 700 while others don’t make adjustments until the scores are lower. No lender can provide a loan for a borrower with a credit score lower than the guideline threshold for the program, however.
- Job stability – The more jobs you have had in the past 2 years, the higher the risk you pose. There are exceptions to this rule, though. If you changed jobs because you received a promotion or you went back to school to get a better job, you are not considered high risk. It is the borrowers that held 3, 4, or 5 jobs in the last two years – they do not show any stability and therefore are risky. The lender chooses to adjust the interest rate accordingly to make up for that risk.
- Lack of assets – Assets play a vital role in the stability of your loan. The more reserves you have on hand, the more likely it is that you do not pose a threat to the lender. Knowing that you have a backup in the event that your current income became unavailable is like an insurance policy for the lender, allowing him to avoid adjusting your interest rate upwards.
- Debt ratio – The higher your debt ratio, the more risk you create for the lender because that means a larger percentage of your income is tied up in monthly debts. This could put your mortgage loan at risk should you reach financial troubles in the future. Most lenders will adjust the interest rate as the debt ratio creeps up.
As you can see, there are ways you can affect your interest rate. If you know you want to apply for a mortgage, start getting your finances in order. Make sure your credit score is as high as it can be for your situation; get your debt ratio down by paying off debts; and work on your job stability so that in the future, a lender will look at your profile and think that you are a good risk rather than a bad one.