Each year, nearly 700,000 homes are sold in the United States. Buying a home is an exciting prospect, especially if it is your first time as a homeowner. When your mortgage gets approved by your bank, one thing you’ll want to be aware of is your interest rate. You’re probably already familiar with them by the time you buy a house, as you’ve likely paid interest for your student loans or credit cards.
But what are mortgage interest rates? How are they determined? How do they affect your mortgage payments?
In this article, we’ll go over these questions to help you understand more about mortgage payments. Read on for more information.
What is a Mortgage Payment?
Starting with the basics, let’s first define what a mortgage payment is.
A mortgage payment is a payment on a home, plus interest. This payment is calculated through a relatively simple formula that includes the price of your home, how many months you’ve spread your payments over, and the interest rate that you were given when you applied for your loan.
For example, if your home costs $200,000, and you put down $20,000, you have $180,000 to repay the bank from which you borrowed. With an interest rate of 3.92% over a period of 25 years, you’ll be paying $942 per month.
In addition to paying the principal amount of $180,000, you’ll also need to pay an interest rate of 3.92%. This means that at the end of your home loan you will have paid the lender $282,652.
You may think; “wow, that’s quite a bit more than how much my home costs!” However, remember that you are borrowing hundreds of thousands of dollars from someone for decades.
What is an Interest Rate?
Simply put, an interest rate is an interest the bank charges you for taking out the mortgage loan. It depends on a variety of things, including if you’ve chosen a fixed or adjustable rate.
A fixed interest rate remains the same for the entirety of the loan. In our first example, if you chose a fixed-rate mortgage at 3.92%, this will stay at 3.92% until you pay off the loan. In this case, your mortgage payments will be the same until you pay them off. However, if you pay another large lump sum toward the house, your mortgage payments may decrease. This will only occur if you ask the lender to recast your loan.
An adjustable-rate mortgage may change over the life of the loan, meaning that your mortgage payment may increase or decrease. With an adjustable-rate mortgage, you usually take out a loan for a certain period, similar to a fixed-rate loan. However, the interest may change over time.
An adjustable-rate mortgage usually has a cap on how high the interest rate can go, but often this is quite high in comparison to fixed-rate loans. The interest rate can increase as often as each year or after a fixed number of years. Initially, the interest rate will be much lower than the fixed interest rate, which can make it more attractive to buyers.
If you plan to invest in a house and move after just a few years, this is often your best bet. This way, you can take advantage of the low interest rate in the first few years, and then sell the home before the interest rate shoots up.
What Influences Interest Rates?
Now that we know the types of interest rates, we can discuss how they’re determined and what influences them. In our example, we mentioned a 3.92% interest rate, but this isn’t necessarily the rate you’ll get. Also, you won’t get the same interest rate as your friend down the street or other people in your family. An interest rate is highly personal and there are many things that affect it.
Your Down Payment
When most people buy a house, they put down a significant amount of money as a “down payment.” This is an interest-free payment on the principle of the house.
The down payment will affect how much your interest is, in that the higher the down payment, the lower the interest rate. This is usually because the lender will see less of a risk, knowing that you personally have more to lose.
That’s why it is a good idea to save as much as possible before purchasing your home. 20% is most often the recommended down payment. But, that is not necessarily the right choice for everyone.
Your credit score matters for a lot of things. In this case, your interest rate will also be determined by your credit score. A higher credit score will mean a lower interest rate. This is because you’re thought to be “trustworthy” as per your history, and therefore not as much of a risk to loan money to. Think of this as your proven track record.
The more of a risk the lending institution sees you, the more your interest rate will go up. If you’re interested in buying a house, working on improving your credit score is a fantastic way to prepare.
Your Loan’s Term
Your loan’s term refers to how long the loan will take to pay off in full. A shorter-term loan, like five to ten years, will typically give you much higher monthly mortgage payments, but lower interest rates.
You’ll pay less over the long term, but more each month until it is paid off. Generally, when getting a home loan you will be offered a 15-year or 30-year loan.
Interest Rates and Mortgage Payments
Now that you have a better understanding of mortgage payments and interest rates, you’ll be better prepared for your first home. We can safely say, interest rates have everything to do with your mortgage payment and how much you’ll owe each month.
If you’re locked in a loan now and interested in changing your monthly mortgage payments, you may wish to consider refinancing. This could change the amount you pay each month, as well as alter the loan percentage.
For more information on all things to do with loans, loan consultations, and information on refinancing, contact us. We can help you build a better future.