Buying a home involves several steps. Besides scouting out the right property, you’ll go through the process of getting a mortgage, ideally one with the best possible interest rate. The lower your rate, the lower your monthly payment and the less your mortgage costs.
If this is your first time getting a mortgage, here are the basics on interest rates.
What is a mortgage interest rate?
The interest rate on your mortgage determines what you’ll pay to borrow money from a lender, expressed as a percentage.
In general, shorter-term loans, like a 15-year mortgage, come with a lower interest rate, but have higher monthly payments. Longer-term loans, such as 30-year mortgage, come with a higher rate, but lower monthly payments. Shorter-term loans typically cost less in total interest.
Mortgage interest rates are determined by many factors, including your credit score. If you have a higher score, you’re much more likely to get a favorable rate.
How does mortgage interest work?
Your mortgage interest is a percentage of your balance. As you repay your mortgage, you’ll make monthly payments based on your loan’s amortization schedule. As your loan matures, more of your payment goes toward the principal, or the actual amount you borrowed. Initially, more of your payment goes to the interest.
Let’s say you have a 30-year fixed-rate mortgage with a balance of $300,000 and an interest rate of 3.2 percent.
Your monthly mortgage payment (principal and interest) would remain $1,297 throughout the 30-year term, but for your first payment, $497 of that would be applied to the principal and $800 would be applied to interest. At around year 15, those proportions flip: $824 of your payment would be applied to the principal and $477 would be applied to the interest. You’ll continue to pay more toward principal, and less toward interest, until the loan is fully repaid.
Let’s say you chose a different mortgage lender, however, and your rate is now 3.5 percent. You’d pay $1,347 monthly toward principal and interest, $50 more per month compared to the above example. You’d also pay approximately $185,000 in interest over the course of the loan, almost $18,000 more than if you had the lower rate.
APR vs. interest rate
The APR, or annual percentage rate, accounts for both your mortgage interest rate and other costs, including lender fees and discount points. APR is also expressed as a percentage, but since it includes these other fees, it is always higher than the interest rate.
The interest rate, on the other hand, can be fixed or adjustable, and only accounts for the cost of borrowing the loan.
By law, lenders have to disclose the APR for a given loan so that borrowers have accurate cost information upfront.
APRs differ from lender to lender, so it’s important to ask what the APR includes. Some APRs don’t include credit report or appraisal fees, for instance.
What are current mortgage rates?
Currently, the benchmark 30-year fixed-rate mortgage is 3.170%, according to Bankrate’s latest lender survey. Mortgage rates have inched slightly higher as of late, but they remain at record lows.
Through Bankrate, you can compare current mortgage rates for 30-year and other types of loans.
What is a good mortgage rate?
Mortgage rates fluctuate frequently, so what’s considered “good” changes over time. While it’s a smart idea to compare mortgage rates online, you’ll also need to compare quotes specifically tailored to your situation in order to find a good rate. One rule of thumb is to get at least three offers so you know what rates are available based on your credit and financial profile.
How to get the best mortgage rate
For the best chance at the lowest mortgage rate, follow these tips:
- Improve your credit score – Lenders offer their lowest rates to those with strong credit. Some ways to boost your score include paying your bills on time and lowering your credit utilization ratio, the ratio of your credit balance to your credit limit.
- Build a record of your work history – Lenders generally look favorably on borrowers with at least two years of consistent employment. If your work history has significant gaps or you’re self-employed, you might have to provide more paperwork to get approved for the best possible rate.
- Save more for a down payment – Putting more money down upfront can help you secure a lower rate. One way to grow your savings is to automatically set aside a portion of your income into a savings account. You can also look into down payment assistance programs, which can help you get the funds you need.
- Compare rates – Comparing offers to find the lowest mortgage rate can save you thousands over the course of a 30-year loan.
- Consider a low-credit mortgage – If your credit score isn’t as high as you’d like it to be, consider getting an FHA loan. FHA loans can sometimes have a lower interest rate, by about a half a point or more, compared to a conventional loan.
- Work with a mortgage broker – A broker can help find you the best deal and negotiate a lower rate, and many don’t charge any fees. Be sure to look for a broker who has experience with the type of loan you’re after.
Your mortgage interest rate impacts how much you’ll pay for your home loan, both on a monthly basis and overall. That’s why it’s crucial to get the lowest rate possible. Some of the best ways to do that are to compare rates regularly, boost your credit score and consider working with a mortgage broker to uncover the best offers.