How are Interest Rates on Loans for Homes Calculated?

By: John Harris

One of the most pressing concerns for first time buyers of homes is understanding how interest rates are determined. While most new buyers of homes understand that the mortgage interest rate will directly affect their monthly payments, there's still a lot of confusion about how the rate is determined to begin with. Here are the basics, and how to can use this information when looking at homes to buy.

How Does the Federal Reserve Impact Mortgages on Homes?

Basically, the Federal Reserve is the entity that determines the interest rates that banks charge each other when they borrow and loan money. How does this affect the amount of interest your mortgage lender charges you? Well, it's the basis for the prime lending rate, or the interest that banks charge their most reliable customers. Prime is usually about 3% above the bank rate. The interest rates mortgage lenders then pass onto you, and their other customers, will be higher to help cover their lending risk and offset those loans for homes that end up defaulted.

Loans for Homes

What this means for buyers of homes is that your individual rate is determined by the spread of rates in your area. Your mortgage lender will set your interest rate based on these key factors: your credit history, income, outstanding debt, and the types of loans for homes you are seeking.

Yes, when it comes to lending- credit scores are king. From the lenders point of view, the best indicator of whether or not you will honor the terms of your home loan are how well you have dealt with past creditors. If you don't already know your FICO (Fair Isaac Corporation) score, you need to become very familiar with this number. It's determined by your credit history, amount owned, how often you apply for cards, length of credit history, and mix of credit types. You want the highest FICO score possible. If it's low you need to read about ways to improve your credit score. This will increase the number of homes available to you.

Your income and outstanding debt will impact your interest rate when obtaining your homes mortgage. In many situations using cash on hand to pay off debt, rather than making a larger down payment, can lower your interest rate.

Finally, the type of home loan you seek will influence your homes mortgage rate. The traditional 30-year conventional mortgage is likely to have a higher interest rate than an ARM (adjustable rate mortgage). Of course, the ARM is subject to change along with the prime rate, so it's a bit riskier. If the prime rate goes up, that means your homes monthly payments increase. You will want to consult a mortgage lender to determine what type of home loan is best for your personal situation.

Final Tips for Buyers of Homes

So the major factors in determining the interest on your home loan are: the federal bank rate, local rates, your personal finances, and the type of loan you seek. First time buyers of homes and seasoned pros need to know how interest lending rates are determined to getting the best rate possible.

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