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Understanding Interest Rates: What to Know Before Buying a Home

Mortgages are great options for prospective homeowners, allowing them to slowly pay off their home instead of paying hundreds of thousands of dollars upfront.

That’s why finding the best mortgage rate is imperative. But when considering different offers, you should look beyond your main mortgage balance.

Every mortgage rate is accompanied by an interest rate, which incurs an additional monthly cost that homeowners must pay. To find the best mortgage offer, homeowners must understand how mortgage interest rates can increase the total cost of their mortgage.

Read on to learn about mortgage interest rates and how they factor into your mortgage. By understanding interest rates, you’ll be ready to choose the best mortgage offer possible.

What is a Mortgage Interest Rate?

A mortgage interest rate is a percentage charged on a mortgage loan balance. This interest is paid monthly to compensate lenders for loaning money to homeowners. So although you’re already paying off your mortgage, you’ll also need to pay a monthly interest fee.

How Are Interest Rates Set?

Interest rates are affected by three main entities — the economy/real estate market, the lender, and the borrower. Each entity interacts with a number of unique factors, some of which borrowers can control or haggle with to receive lower interest rates.

State of the Market

The economy, stock market, and real estate market all affect how investors calculate their fees. Lenders will take advantage of a strong economy/market by charging higher interest rates.

The Lender

All lenders charge different interest fees. That’s why borrowers should interact with various lenders so that they have different mortgage rate options to choose from.

The Borrower

Lenders gauge the risk of their investments by examining borrowers’ financial situations. If a borrower has poor finances, lenders will charge higher interest rates to ensure a profitable return.

What Can I Do to Lower My Interest Rate?

Factors such as the real estate market and national economy are out of your control. But you can control your finances in advance to get better rates.

1. Credit Score

A credit score of 500+ can access some mortgage rates. But the most competitive interest rates usually need a credit score of 760+.

If you have time, work on your credit score so that you can qualify for better interest rates. Even if your credit score doesn’t reach 760, increasing your score at all can lower your total mortgage balance by thousands of dollars.

2. Property Location

Lenders will offer varying interest rates depending on the state, county, or area type your property is in. If you’re set on your home’s location, prepare for the interest rates the area typically comes with. Farmland homeowners can even take advantage of farm mortgage loans that specialize in agricultural services.

3. Loan Term

Short-term mortgage loans are typically 15 years while long-term loans are usually 30 years. Loans with shorter terms charge lower interest rates than those with longer terms, resulting in lower monthly interest payments.

However, short-term loans charge a higher monthly payment, meaning that while you’ll save more money overall, your monthly budget will be higher. Weigh out your options and understand what’s realistically viable. While short-term loans are most ideal, you might want to take out a long-term loan if you cannot pay a higher monthly interest rate for 15 years.

4. Interest Rate Type

Some interest rates are fixed, meaning that the fee will not change through mortgage payments. But adjustable interest rates typically start low and start to increase based on changes in the real estate market.

If you prefer predictability, then you’ll want to take out a fixed-rate loan. But if you can conquer the odds of the real estate market, then an adjustable-rate loan could be your best option.

5. Down Payment

If you finance a down payment of 20% or more, you can lower your loan balance and receive more equity for your home. Lowering your loan balance will lower your interest rates, allowing you to pay less interest every month.

6. Mortgage Points

Similarly to down payments, mortgage points are paid to the lender beforehand. Doing so will lower the overall interest rate and help you save interest over a loan’s term.

One point equals 1% of your mortgage amount. That means if your mortgage costs $200,000, then one point equals $2000. Using points when you can afford to can loosen up your monthly budget for years to come.

How Does My Interest Rate Affect My APR?

Certain fees aren’t incurred by the lender at all but are still necessary for borrowers to pay. That’s where APR comes in. While your interest rate reflects your mortgage loan, your APR reflects the annual total of your loan, interest rate, and other fees.

Mortgage interest rates are important to understand, but your APR will represent the bigger picture. But that doesn’t mean that your APR is necessarily the most important factor to consider when choosing a mortgage loan. In fact, you may not have to worry about APR if you pay on time and in full.

Get the Best Deal by Understanding Interest Rates

Before you buy your home, realize that you can control how much you pay. Not only can you pick your mortgage, but you can also lower your interest rate by taking many steps to get the best offer.

Prepare your credit score and save money to pay your lender upfront. Choose the right lender, interest rate type, and loan term. All these choices can help you save thousands of dollars and liberate your monthly budget.

We hope that this guide to understanding interest rates helps you choose the best interest rate. If it did, check out the rest of our site! Our blog features plenty of information meant to help people navigate their life and finances.

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