How Do Mortgage Rates Work? What You Can Do to Get the Best Rates

By Alvaro Moreira
4 min read

The number of bedrooms and bathrooms is perhaps at the top of your list of home-buying wants, and while they are all important considerations, getting a good mortgage rate should also be a top priority.

Mortgage lending practices and details can be confusing whether you are looking to refinance or getting a new home loan, especially if you are a first-time homebuyer. Below you will find answers to questions you may have about how mortgages work, how mortgage rates are determined and tips for getting the best mortgage rates.

mortgage rate

How Do Mortgage Rates Work?

Mortgage rates work in much the same way as other types of loan interest rates. The lender charges a certain percentage of the principal borrowed over time. The principal, in the case of a mortgage, refers to the amount you have to borrow to purchase the home.

Simply put, mortgage rates are indicative of the cost of credit that’s extended to you. The lower the rate you are offered, the lower your cost of borrowing and the less you will be required to pay over the life of the home loan.

How Is the Mortgage Rate Determined?

The mortgage rate is determined by several factors. You probably already know that your credit score determines to a great extent the rates that you may qualify for. Still, lenders consider things such as the type of loan chosen, the amount put down upfront, and the current rate environment when determining the mortgage rate.

Different Mortgage Types Offer Different Rates

The two main types of home loans are fixed-rate and adjustable-rate mortgages (ARMs) and the rates offered usually vary depending on the type of mortgage that you choose.

A fixed-rate mortgage lets you lock in the same interest rate for the life of the loan.

Adjustable-rate mortgages, on the other hand, offer a fixed interest rate for a set period of time, like 5, 7, or 10 years. After that period, the loan will have a variable rate that fluctuates depending on the market conditions.

Adjustable-rate mortgages usually have lower fixed interest rates at the outset. However, fixed-rate mortgages offer long-term predictability.

Jumbo loans are mortgages where borrowers are allowed to take out a loan for more than the conforming loan limit as determined by the federal government. Rates for jumbo loans are sometimes lower than conventional mortgages.

Vacation Home or Condo? The Type of Property Also Matters

Do you want to finance a rental property? Move into a bigger home since your family is growing? The type of property that you will use the loan for will end up affecting the mortgage rate that you can get. 

For instance, mortgage rates for investment properties or second homes are typically higher compared to those of primary residence. Make sure that you compare the mortgage rates for the same type of properties when shopping for loans.

How Can You Get the Best Rates?

The economy is definitely beyond your control, but you can still do certain things to ensure that you get the best possible mortgage rates.

1. Improve Your Credit Score

The credit score allows lenders to assess your ability to actually pay back your loans, which is based on your borrowing history. It is why your credit score has a direct impact on the rates that you qualify for. The higher your credit score, the better the rates you can get, which can lead to significant savings over the life of the mortgage.

2. Shop and Compare

Annual percentage rates, interest rates, mortgage rates – that’s a lot of rates. However, the reality is that those numbers are not necessarily interchangeable. Comparing interest rates is obviously a good place to start, but those just tell part of the story. What you should really know is the annual percentage rate (APR) on any loan that you’re considering.

3. Make a Sizeable Down Payment

The down payment is the amount that you pay up front for your loan. The size of the down payment can end up affecting the mortgage rate. Typically, the bigger the down payment you make, the lower the mortgage rate. Keep in mind, however, that the exact impact of the down payment will depend on your unique financial situation.

20% of the total loan amount is a typical down payment, but paying either more or less can affect your monthly mortgage payment amount. You can see how different down payment amounts affect your monthly payment by punching your numbers into a mortgage calculator.

4. Pay Down Mortgage Points

You may be able to “buy” a lower rate by prepaying some of the interest, known as “points” depending on the lender you work with. The more points you buy, the lower the interest rate you can get on your loan.

While it might seem appealing to buy a lower rate, don’t forget that it actually might not be worth the expense depending on how soon you sell or refinance your home.

Lenders Will Have the Final Say

The terms of any loan are always up to the lender that extends the credit. Each lender typically takes the above factors into consideration before setting the rates and terms to offer. It is also up to individual lenders to determine how much to charge in closing costs, lender fees, etc.

To have a good comparison, get a loan estimate for each loan you are considering. A loan estimate includes all the closing costs, which include lender origination fees and an estimate of the required third-party fees such as recording fees, appraisal, title, and taxes.

Now that you have a better understanding of how lenders determine mortgage rates and steps to take to get a better rate, buying a home with your desired bed to bath ratio is simply the icing on the cake. Once you are ready to take the next step, get in touch with a Home Loan Expert to guide you through the process.