The homebuying process can be exciting, challenging and stressful. One of the biggest aspects is getting a mortgage so you can afford to buy a home in the first place. And of course, you’ll want to secure a mortgage that gives you the best terms possible.One of the first things you’ll notice is that mortgage interest rates vary from lender to lender. In fact, they can vary a lot. That’s important when you consider that a difference of 1% can result in thousands of dollars more in interest down the line.
Given the amount of variability among interest rates, shopping around is essential. Research from Freddie Mac finds that getting just one additional mortgage rate quote saves homebuyers an average of $1,500 over the life of a loan. Getting five quotes saves an average of $3,000.
By understanding why rates differ so much from lender to lender, you can better prepare yourself for the mortgage search process — and set yourself up for success.
Why do rates differ by lender?
There are a number of reasons mortgage rates differ — and change so quickly over time. Larger economic trends are one major factor. Interest rates fluctuate due to factors such as the Federal Reserve policy, the bond market, inflation and economic growth. The housing market itself also has an impact. When fewer homes are being bought and sold, this lowers the demand for mortgages and thus has a downward effect on mortgage rates. Other differences are more specific to the lenders themselves:
Competition. Just like with any other business, competition is usually good for keeping prices down for consumers. So if you live in an area with a lot of lending options, lenders may offer more competitive rates to bring in business.
Risk assessment. Each lender has its own team of underwriters and risk assessment guidelines. Using their guidelines, one lender might find a borrower higher risk than another lender would, and therefore charge a higher rate. For lenders who give loans to “riskier” borrowers (such as online lenders who often give loans to people with lower credit scores), interest rates would also be higher.
Funding costs. It costs money to lend money, so each lender will have its own costs, which could influence the interest rates it offers.
Operating expenses. How much it costs to run each lending institution will vary depending on whether the lender is a large brick and mortar bank, a small community bank or an online lender.
Profit margin. Most lenders are for-profit, so they will want to make money off of each loan, which will determine the interest rate they charge. Credit unions, though, are nonprofit and usually offer lower loan interest rates than banks because they have lower profit margins.
Why is my rate different from the advertised rate?
When you’re shopping around for mortgages, you may find that the rate a particular lender advertises is different than the one you are offered. That’s because the rate you’re quoted takes into account multiple factors unique to your situation.
Credit score. Your credit plays a very big factor in your interest rate. Typically, the higher your credit score, the lower the interest rate you’ll be offered.
You can get an idea of how your credit score and other factors affect the loan rate you can expect by using the Consumer Finance Protection Bureau’s Explore Interest Rates tool. The tool gives you an idea of average interest rates by taking into account your credit score, the state where you’re taking out the loan, the size of your mortgage, your loan terms and the size of your down payment.
Loan terms. The details of your loan also play into the equation. Most lenders advertise rates for “ideal” situations. For example, many assume a fixed-rate loan with a 20% down payment. The size of your down payment is essential, as you’ll typically get a lower interest rate if you make a larger down payment. You may also pay more for a loan that’s either unusually small or large.
The loan’s term, or how long it is, is another variable that may result in a rate different than the one advertised. In general, the shorter the term, the lower your interest rate and overall costs will be, although your monthly payments will be larger.
Whether your loan is fixed or adjustable is another factor. While a fixed rate stays the same over time, an adjustable rate will go up or down based on the market.
Loan-to-value ratio. Your loan-to-value, or LTV, ratio is another essential calculation that has an impact on your rate offer. Your LTV is the relationship between the amount you’re borrowing and the overall value of the home. The larger your down payment, the lower your LTV will be. You may be quoted a higher interest rate if you have a high LTV.
In general, lenders look for an LTV of 80%. If your LTV is above 80%, you’ll likely have to pay for private mortgage insurance to help protect your lender until you build up at least 20% equity in your home.
APR vs. interest rate
As you’re shopping around for a mortgage, you’ll want to consider the interest rate offered by the various lenders. This shows you the cost of borrowing the money. In addition, you’ll want to review the annual percentage rate, or APR.
The APR gives you a fuller picture of how much the loan will really cost you because it includes not just your interest rate but also costs like broker fees, any points you might be paying to get a lower interest rate and other fees you’ll be charged.
The formula for calculating APR is as follows:
Fees (origination and interest) / principal (including closing costs) / number of days in the loan x 365 x 100
Let’s assume you have a 30-year, fixed rate mortgage of $250,000 with a 4.5% interest rate. If your closing costs equal 2% of the loan ($5,000) and you pay a 1% origination fee ($2,500), using an online calculator, your APR would equal 4.75%.
Do rates vary by state?
Geography plays a role in mortgage rates. Interest rates likely will vary from state to state for several reasons, including
Foreclosure rates and laws. If there’s a high incidence of foreclosure in a certain area, this can increase the costs for a lender, which they then pass on to you in the form of higher interest rates.
The cost of doing business in a given state is also important. If it’s more expensive to operate due to state taxes and wages, these costs may be reflected in the mortgage.
Population. Heavily populated areas with multiple lenders may offer lower rates because they have more competitors for your business. But on the other hand, while lenders in less-populated may have fewer competitors, they also have fewer customers to choose from. That may compel them to offer lower rates, too.
If I lock in my rate, can I renegotiate if rates go down?
As you’re shopping around, potential lenders will likely encourage you to lock down a rate. Because interest rates are constantly fluctuating, a rate lock can help you eliminate the risk that you’ll pay a higher rate than the one offered now.
Once you lock in a rate, the lender will guarantee that rate to you for a set period of time — they typically require that you close within 30 to 60 days. Note that you will usually pay a fee to lock down a rate.
It’s important to know that a rate lock doesn’t guarantee that you’ll still qualify for the same rate when you close. For example, if you face issues with your income verification or credit, or if your home appraisal hits a snag, the rate may be adjusted.
One downside to a rate lock is the possibility of rates going down. If that happens, you’re likely stuck with the original higher rate that you locked in. If you are concerned about that possibility, consider adding a float-down provision to your rate lock. This will allow you to adjust your rate should the rates go down.
There are many factors that influence the mortgage interest rate you’re offered. Some are factors you bring to the table like your credit score and the size of your down payment, while offers are based on the individual lenders. It makes sense to do some comparative shopping and get offers from at least a few lenders to get the best rates.
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