How Do Mortgage Interest Rates Work?
Finding a mortgage with an affordable interest rate can make or break a house purchase. The higher your interest rate, the more you pay each month and the more you pay overall. So to make sure you can buy your dream home, you’ll want to find a mortgage with the lowest possible interest rate.
But lenders don’t offer the same rates to every borrower. There are several factors that affect how interest is calculated on a mortgage – and there are a few actions you can take to bring that rate down. Before you agree to or even apply for a mortgage, make sure you have mortgage interest rates explained by a knowledgeable, experienced source.
What is Interest?
Put simply, interest is a charge for borrowing money. It’s usually expressed as a percentage of your loan. A lender charges interest on a mortgage loan for three main reasons:
- To cover the cost of obtaining the funds and administering the loan
- To offset the risk of lending money
- To make a profit on the loan
First-time home buyer? Check out our guide.
How is Interest Calculated on a Mortgage?
The amount of interest added to a mortgage loan differs from lender to lender and from loan to loan. Here are the main factors that increase or decrease the interest rate you might be offered, along with some tips for getting an affordable rate.
Your monthly mortgage payments cover both the amount you originally borrowed (known as your principal) and your interest. At the start of your repayment period, a larger portion goes toward your interest, which ensures the lender earns its fee for the loan. As time goes by, the principal portion of your payment increases while the interest portion decreases.
Type of Mortgage
When you take out a mortgage, there are two main types of loan you might be offered. Which type you choose affects your monthly interest payments:
- Fixed-Rate Mortgage: Your loan has a set, unchanging interest rate for its entire repayment term. With a fixed-rate mortgage, your payments are the same every month regardless of market changes. These loans are very stable and can save lots of money if you borrow when interest rates are low. But unlike an adjustable-rate mortgage, your initial rates tend to be higher.
- Adjustable-Rate Mortgage: The interest on your loan changes over time depending on rises and falls in market indexes. This can save you money if rates remain low, but can cost you more if they spike. However, there’s usually a cap on how much the rate can change each month. The initial interest rate also tends to be very competitive for the first 5-10 years.
Most borrowers take on a mortgage loan with a 15-, 20-, or 30-year repayment term. Longer terms generally come with higher interest rates, meaning you pay a higher total cost. Paying off your loan quickly can save you money in the long run, but also means that your monthly repayments would be higher. Always choose a mortgage term based on what you realistically can afford.
Loans always put the lender at a financial risk. If you can’t pay it back, they lose money.
Your credit score is essentially a numerical representation of how likely you are to pay off your loan successfully. When your credit score is high, the lender can have more confidence in your repayments. That means they can offer you a lower interest rate.
Your credit score is based on your credit history. This is affected by factors like:
- Your repayment history
- The total debt you carry
- Your number of open accounts
- How often you apply for credit
- How often you reach your credit limit
It’s tough to raise your credit score quickly in a short amount of time. So be sure to practice good financial behaviors to earn a high credit score and enjoy lower interest rates.
The interest you pay on your mortgage depends on how much you owe. If you make a 10% down payment, you’ll only need to borrow and pay interest on the remaining 90%. If you make a 15% down payment, you only need to cover the remaining 85%. The larger your down payment, the less mortgage interest you’ll have to pay.
Now All You Need is the Right Real Estate Agent
Taking these factors into account will help you to find a mortgage with an affordable interest rate. But there’s more to buying property than just having mortgage interest rates explained. You also need to work with a talented real estate agency who can match you with the home of your dreams.
At Stephens Real Estate, we have over 45 years’ experience in helping people like you buy beautiful, well-positioned properties around Lawrence. We know the local area like the back of our hand and offer a highly personalized service that meets your particular wants and needs. Make your property search a breeze by contacting our friendly expert team today.