Are you looking for the best possible mortgage rate? Do you want to know how mortgage rates are determined so that you can negotiate the best deal for yourself?
In this article, we’ll explain how lenders and other factors affect your mortgage interest rate, so you’ll feel confident about finding a loan that’s right for you. From understanding the Federal Reserve’s influence to tips for getting the best mortgage rate, read on to learn more about everything involved in securing an excellent deal on your investment property loan.
What Determines Mortgage Interest Rates?
Mortgage interest rates are determined by several factors, including the Federal Reserve’s monetary policy, inflation, and competition among lenders.
The Federal Reserve manipulates the money supply to influence short-term lending rates. When they set a target rate or lower it, they make it attractive for banks to borrow money from each other at low rates, which helps keep mortgage rates low for homebuyers. Conversely, when Federal Reserve policies like quantitative tightening or monetary policy decrease credit availability, this can create further upward pressure on mortgage interest rates.
Inflation also has a major impact on mortgage rates. When the cost of living rises, inflation and the price of money increase. This means lenders must adjust their loan rates to keep up with inflation, making them more expensive. The higher the inflation rate, the higher the mortgage rate will be.
During economic downturns and times of rising inflation, lenders may become more conservative when granting loans, limiting the number of loan products available and increasing interest rates. On the other hand, when times are good, banks compete for customers and offer increasingly better deals on home loans.
A Closer Look at How the Federal Reserve Impacts Mortgage Rates
Government policies—specifically those leveraged by the Federal Reserve—act as a major influencer and driver of fluctuations in lending trends affecting homeowners and real estate investors alike.
Interest rates on mortgages, home equity loans, and other consumer debt are based on the Federal Reserve’s benchmark rate. So when the Federal Reserve raises or lowers its benchmark interest rate, it affects mortgage rates. That’s because mortgage lenders tend to follow the Fed’s lead, meaning when the Fed increases its rate, lenders often increase their interest rates as well, and vice versa.
Mortgage rates are directly tied to the bond market and the Fed funds rate. High demand for bonds pushes prices higher, which decreases yields (i.e., interest rates). Conversely, low demand for bonds tends to push prices lower, which increases yields. The most sensitive bond in this regard is the 1-year treasury that closely tracks changes in the federal funds rate. As investors perceive more risk in owning mortgage bonds or mortgage-backed securities, they require a higher return, driving yields and rates up.
The 10-year treasury yield closely corresponds with long-term fixed mortgage rates and is generally seen as an indicator of where those lending costs are going in the future. So, if investors think that inflation is going up and interest rates will follow, they will put their money into 10-Year Treasuries instead of 30-Year Mortgage Bonds, thus pushing 30-year mortgage yields up.
Fluctuations in economic activity and changing investor sentiment largely drive changes in available liquidity, ultimately impacting current loan markets like consumer debt and mortgages. For example, lower treasury yields generally mean lower borrowing costs for consumers looking for home mortgages, while higher treasury yields can lead to slightly more expensive housing loans due to increased demand for added return on invested capital.
Factors That Influence Your Mortgage Rate
Understanding how mortgage rates are determined can help you make sound decisions about your investments and help make sure you get the best deal possible. From lender practices to credit scores and loan-to-value ratios, various elements can have a major impact on your final interest rate.
Lender
Different lenders offer varying mortgage rates, so it’s important to shop around and compare all your options before making a decision.
For instance, FHA loans are insured by the Federal Housing Administration, which can help you secure a loan with more favorable terms than conventional lenders. Freddie Mac and USDA Loans have similar advantages – they offer low mortgage rates and may not require private mortgage insurance (PMI). On the other hand, VA laons provide an exclusive benefit for veterans – they don’t require a down payment at all.
Mortgage rates can vary widely by lender or even within different regions of the country. For example, borrowers in certain states may be eligible for lower rates due to geographical differences in market conditions or economic growth trends.
Credit Score
Credit scores are issued by the three major U.S. consumer credit bureaus – Equifax, Experian, and TransUnion. These bureaus collect and store information about your financial history, including information from lenders, such as the amount of credit you have access to and the payment history on that credit. They then use this data to generate a score that reflects your overall creditworthiness.
The major credit bureaus use several different credit score ranges. Generally, a FICO score between 300 and 850 is considered:
- 300-559: Poor/Bad Credit
- 560-659: Fair Credit
- 660-724: Good Credit
- 725-850: Excellent Credit
As a general rule of thumb, having a higher credit rating can give you access to lower interest rates on mortgages or other types of loans. To ensure your credit score remains in good standing, make sure you pay all your bills on time and keep your credit card balances and outstanding debts as low as possible.
Down Payment
Making a larger down payment on a home has plenty of advantages that real estate investors should consider. For example, it increases the likelihood of being approved for more favorable interest rates and reduces the loan amount you need to borrow.
An increased investment upfront can also give you added financial security. You’ll have more equity in your property right away and lower overall mortgage payments due to a lower principal balance being financed.
On the other hand, lower down payments may provide more flexibility in cash management and capital reserves but will also result in higher monthly mortgage payments. In addition, larger origination fees and closing costs could also be associated with the loan.
Loan-to-Value Ratio (LTV)
Loan-to-value ratio (LTV) is a measurement of the size of a loan compared to the value of an asset securing that loan.
For example, let’s assume you want to purchase a home with a purchase price of $200,000, and you provide a 20% down payment. In this case, you will take out a mortgage loan for $160,000. Therefore, your loan-to-value ratio is 80% ($160,000 / $200,000 = .80 x 100). On the other hand, if you only put 10% down on the same property, your LTV would be 90%, meaning the lender is taking on more risk than in the first scenario due to less equity in the property.
The effect of LTV on a borrower’s interest rate depends on several factors, but generally speaking, if borrowers have a lower LTV, they will receive better interest rates. On the other hand, borrowers with higher LTVs often face stricter requirements and higher interest rates because lenders must protect their interests from greater risks associated with large loans.
Debt-to-Income Ratio
Debt-to-Income ratio (DTI) is another important factor for borrowers to consider. DTI measures a borrower’s total debt compared to their gross income.
For example, let’s assume that you have a monthly gross income of $8,000, and your total monthly debt payments are $2,400. Your DTI would be 30%, calculated by dividing $2,400 by $8,000, which most lenders generally consider a manageable amount.
However, if your monthly debts were higher and equaled $4,200 per month, your DTI would be 52.5%. This higher ratio may affect the interest rate offered by lenders because it indicates a greater risk for them due to the borrower having fewer financial resources available to repay the loan.
Lenders often use both an applicant’s LTV and DTI ratios as indicators of risk level when determining mortgage rates. Generally speaking, applicants with lower LTVs and DTIs receive better interest rates than those with higher ratios or are too close to the maximum allowable limit set by that lender or governmental policy.
Fixed-Rate Mortgage vs. Adjustable Rate Mortgages (ARMs)
Mortgage rates come in two varieties — fixed-rate mortgages (FRM) and adjustable-rate mortgages (ARM). Fixed-rate loans offer borrowers the security of a fixed interest rate over the life of the loan, while ARMs start with an introductory period of lower payments that can change when the introductory period ends.
The main advantage of a fixed-rate mortgage is that it provides borrowers with certainty regarding their monthly payments and total interest due on the loan. Borrowers know up front how much they will be paying for their mortgage and don’t have to worry about any changes during the course of their loan. One possible downside to FRMs is that if market rates decline after closing, borrowers cannot take advantage of those lower rates without refinancing or facing early repayment penalties.
ARMs offer flexibility by allowing borrowers to take advantage of lower rates for a set period, typically 3-7 years, before the rate resets and begins to reflect market conditions. This option could be attractive for those who plan on selling or refinancing within this time frame and for borrowers who cannot initially qualify for a higher mortgage with an FRM. However, there is risk involved because if market rates increase during this time, so will monthly payments and total interest paid over the life of the loan.
Refinancing
Refinancing is a popular strategy real estate investors use to access additional funds and secure lower interest rates and shorter repayment periods. Current mortgage rates are essential when determining if refinancing is the right choice for an investor, as they directly impact loan terms and monthly payments.
When mortgage rates are low, investors may choose to refinance their existing loans to lock in these favorable rates and save money on their total interest costs. This benefits longer-term investments or those made with jumbo loans, which tend to carry higher interest rates than other financing types.
Refinancing can also be attractive for borrowers looking to take advantage of equity built up in their property via cash-out refinancing or reduce the length of their loan repayment period.
How Can You Get the Best Mortgage Rate?
Securing the best mortgage rate is an essential step in any home loan process, as it can significantly impact total interest costs over time. Fortunately, with the right strategies, borrowers can get the best possible rate and save money in the long term. Here are a few tips to consider when looking to get the best mortgage rate:
- Shop around – Take the time to compare different lenders, terms, and rates to get the best deal.
- Good credit score – A good credit score is essential when getting approved for low-rate loans.
- Down payment – The larger the down payment, the lower your interest rate may be.
- Compare loan options – Consider different types of loans, such as fixed-rate and adjustable-rate mortgages, to find one that fits your needs.
- Get pre-approved – Showing lenders that you have already been pre-approved for financing can increase your bargaining power and potentially qualify you for more competitive rates.
Closing Thoughts
Mortgage rates are determined by various factors and criteria, from the Federal Reserve’s policies and current marketplace trends to the size of a down payment and the borrower’s credit score. Therefore, real estate investors need to understand each factor to make an informed decision when selecting a loan option.
Finding the best loan program for a real estate investment can be challenging if you try to figure everything out independently. Despite the abundance of possibilities, each is accompanied by a certain degree of risk.
Investing through Arrived can significantly reduce the uncertainty and effort of locating and managing properties. Browse available investment homes today and see how your initial investment could grow over the next few years.
