how banks determine mortgage rates

The story behind the numbers

But when you’re ready to shop for a mortgage, you may be surprised to find that the mortgage rate offered by your lender is slightly different than those advertised rates. That’s not a mistake: When the time comes to lock in your loan, banks use the specifics of your situation to set the actual rate you end up paying.

Here are the key factors they consider:

• Credit score – Generally, the higher your credit score is, the lower your rate will be. Most banks consider FICO scores above 740 as an indication you’re likely to repay your loan more dependably than those with lower scores. Inaccurate information on your credit report could cause your bank to categorize you as a riskier borrower than you actually are, in which case you could wind up with a higher mortgage rate than you actually deserve. So, get a copy of your credit report from one of the top credit bureaus (Equifax, TransUnion or Experian) and check it carefully. Freecreditreport.com is a free and trusted way to get your credit score. If you find any errors, contact the credit bureau to resolve them before you apply for a loan.
• The size of your loan vs. the price of your house – This figure, also known as the loan-to-value ratio, captures how much of the purchase price you’re willing to pay up front. If you can make a down payment of at least 20% of your home’s price, you’re likely to get a lower interest rate.
• The length of your loan – The longer you’ll spend paying back your loan, the higher your mortgage rate will be. Mortgages with a 30-year term are among the most common, but they usually carry higher rates than mortgages with terms of 10, 15 or 20 years.
• Loan type – Adjustable rate mortgages often have a lower initial rate than fixed-rate mortgages—but after a specified number of years, those rates will change to reflect current loan markets. The timing of the adjustment and the way the bank calculates the adjusted rate will be detailed in your loan agreement, so make sure to read and understand it carefully.
• Economic factors – Mortgage rates rise and fall in response to changes in the general economy, such as shifts in the inflation rate or job growth.

Now that you understand what affects your mortgage rate, you’ll be better equipped to understand whether the rate you’re being offered is right for your particular situation.