How mortgage interest rates work

For most, buying a home is the largest financial decision that you can make in your lifetime. Mortgage loans are specific to housing and work in various ways depending on how much money you have at the start, how much money you borrow, and at what rate you plan to pay it back.

The longer you choose to spread out your payments, the max being 30 years, the more you will pay for the total home purchase price. In other words, the longer you take to pay it back, the more interest will be charged to you.

Pre-approval process
Many factors go into an interest rate, so it is best to go through the pre-approval process for a mortgage. Once you’ve picked a lender, either through your own research or through a mortgage broker, you will submit all your income information, debts, and credit score for review to see how much a particular lender is willing to lend you. This gives you the opportunity to figure out any issues you might have later in the process of buying a home. Even a pre-qualification would suffice because it is a conversation with a mortgage lender to see where you stand with your finances. Determining if you’re both ready and equipped to make such a large purchase will be beneficial in the long run.

Calculating your interest rate
Interest rates will determine how much money you pay each month. Within that payment will be both the interest, the cost to borrow money, and the principal amount, the amount you borrowed. Through the pre-approval process, you should have determined the amount you’re qualified to borrow. With a property in mind, consider the down payment and then the amount you will need to borrow. Mortgage interest rates are determined by the market indexes or by a fixed rate determined by your lender.

Fixed vs ARM vs interest-only mortgages

A fixed-rate mortgage means you have an interest rate that does not change for the term of your loan. The benefit is having a set amount to pay each month that you can plan for easily. The downside is that there are other options that may give you a better interest rate.

An ARM or adjustable-rate mortgage is determined solely by the market and the terms between you and your lender. If you decide to go this route, your interest rate will change throughout the length of the loan but with a fixed rate in the beginning. Decide whether you want 7/1, 7 years of a fixed rate, and then an interest rate adjustment every year thereafter, or a 5/1, 5 years of fixed-rate, and then an interest rate adjustment every year. Or you can agree to pay the market rate as it adjusts every year of your loan length. Be aware that the lender will mark-up the interest rate percentage but that should be decided upon before the loan starts.

An interest-only loan is just that. You pay towards the interest rate only, which doesn’t pay towards the principal amount at all. Your total payment is the same each month with 100% of the payment going towards interest and zero to the actual borrowed amount. So if you’re looking to have lower costs in the beginning, this might be an option, if it’s something you can negotiate. It could benefit situations where your income will increase in the following years, or you only plan to stay in the home for a short time before you decide to sell. Keep in mind with an interest-only mortgage loan, you will never own the property and the full mortgage amount will be due at the end of the term.

Determine what is suitable for you
Interest rates are dependent upon your individual situation. It depends on the price of the property you’re looking to purchase, the amount of cash you can use for a down payment, the amount of the loan, which lender you choose to work with, your credit score and income, where you purchase a home, and ultimately how long you plan to stay there.

Interest rates will always fluctuate with the market and your risk level, as decided upon by a lender. So if you’re planning to buy a home, do the research, assess your situation, and choose the mortgage loan that works for you, at whatever point in your life you’re in!

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