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Seven Factors That Determine Your Interest Rate

Seven Factors that can determine your interest rate

Potential home buyers want the lowest interest rate they get. But how are interest rates determined? Even the savviest buyers may not understand how their interest rates are calculated.

Saving even a tenth of a percent in interest equals thousands of dollars in savings over the life of the loan. Because of this, it pays to know how to get the best interest rate possible. The following are 7 factors that help determine the interest rate a buyer qualifies for.

1. Credit Score

Credit score is the primary predictor for interest rate. In general, the higher the credit score the lower the interest rate. This is because lenders view credit score as an overall reflection of financial security – and how likely a borrower is to repay the loan on time.

Credit scores are determined by a borrower’s credit history including employment, loans, credit cards, and payment history. Potential borrowers should check their credit score at least six months before they plan on applying for a mortgage to allow time for any errors to be disputed and corrected.

2. Loan Amount

Homebuyers who are taking out particularly large – or small – loans may be subject to higher interest rates. Potential buyers should calculate the amount they need to borrow as the price of the home plus closing costs minus the down payment. Mortgage insurance may also be included in the loan amount.

3. Home Location

Interest rates may vary slightly by state. In rural areas, for example, local lenders may be able to offer buyers better rates than a nationwide bank. Likewise, borrowers may find that interest rates in hot markets such as New York City or San Francisco are higher than in nearby suburban areas.

4. Down Payment

In general, homeowners putting a larger down payment towards the purchase of a property can qualify for lower interest rates. This is because in the eyes of lenders a large down payment equals a low level of risk as buyers have a bigger stake in the property. Putting more than 20% down may be able to be able to help lower the interest rates by a few percentage points; likewise, a down payment of at least 20% also means that no private mortgage insurance, or PMI, is needed.

5. Loan

The term, or duration, of the loan is the amount of time a borrower has to pay back the amount. In general, shorter term loans, such as 15-year mortgages, have lower interest rates. This can lead to long-term savings; while the monthly payments may be higher, the overall amount of interest paid is significantly lower.

6. Type of Interest Rate

Interest rates can be fixed or adjustable. Fixed rates stay the same for the entire length of the loan. Adjustable rates, however, may go up or down based on the market after the initial fixed period ends.

Loan Type

There are several categories of loans including conventional, FHA, USDA, VA, and more. These different loans have different eligibility requirements – and often come with different interest rates. Shopping between different lenders and different loan types can help buyers find the best loan – and lowest rates – for their new home.

by Author, Dec. 1, 2020

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