Mortgage lenders have a systematic approach to determine how a borrower qualifies for a specific interest rate. While it may seem obvious that borrowers want to receive the lowest interest rate, most rarely understand the following mechanics that help to determine how this works. The factors that determine your interest rate are:
- FICO/credit scores
- Loan-to-Value
- Loan Amount & Location
- Occupancy
- Loan Term
1.) FICO scores, also known as credit scores, directly reflect the creditworthiness of an individual throughout their lifetime. It is a statistical number that ranges from 300-850, and is based on one’s credit history.
Mortgage lenders use these scores to evaluate the probability that a borrower will be able to repay his or her debts. While most scores fall between 600-750, any score above 700 is considered good, and anything above 740 is considered to be excellent.
The higher the score the better. A good FICO score can save you thousands in interest over the lifetime of your loan by allowing the borrower to qualify for a lower interest rate.
2.) The Loan-to-Value, or LTV, is the amount of the loan compared to the value of the property being financed. It is used by mortgage lenders as a way to measure the amount of risk the lender is taking by issuing a mortgage.
The risk is the property devaluing and being worth less than the loan against it. The higher the Loan-to-Value, the higher the risk, which typically results in a higher interest rate. Every mortgage lender has their own spectrum as to how Loan-to-Value impacts the interest rate but the key marker that most lenders abide by is if the LTV is above 80%. Once a borrower falls above 80% LTV, the borrower will have some form of mortgage insurance or a rate adjustment.
3.) Loan Amount & Location: The interest rate can differ depending on the loan amount and sometimes the location where a borrower decides to purchase a home. Conforming loan limits are issued for Conventional, FHA, and VA loans and vary depending on the county where the property is located. Some high cost counties, such as San Diego County, will have High Balance loan limits allowing the borrower to qualify for a better interest rate. The limit that a loan amount falls within will affect the interest rate on the loan. Generally speaking, if the loan is in a higher limit, the risk adjustments to the interest rate will be greater.
4.) Occupancy: There are three occupancy types that help to determine interest rates. They consist of Primary homes, Second homes, and Investment properties. A Primary home is defined by the fact that a borrower is living there for at least six months out of the year. A Second home is a home that is used part time. And lastly, an Investment property is one that is treated as a rental property. Interest rates tend to be lower on primary homes and higher on investment properties.
5.) Loan term: The Loan Term is the duration of how long the borrower will have to repay the new mortgage. If the borrower chooses a shorter loan term, it will result in a lower interest rate and overall cost but will have a higher monthly mortgage payment.
For example, a 15 Year Fixed mortgage will feature a lower interest rate then a 30 Year Fixed mortgage term, resulting in significantly less in interest charges over the life of the loan but the monthly payments will be higher because the length of the loan is cut in half.
There are other factors that directly affect interest rates, but these are the fundamentals. Bluefire Mortgage will help you structure your loan to get the best possible interest rate and find the lowest rate on the market. If you have any questions, feel free to reach out to us directly at (760) 930-0569.
