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How to Calculate (and Save) on Your Mortgage Interest Rate

If you're like most people, you want low interest rates. That way, you can save hundreds, if not thousands of dollars, when buying a home. Understanding the factors that go into mortgage rates will prepare you for the home buying process and negotiating the best interest rates possible.

Your Credit Score

People with robust finances and credit histories typically get the best mortgage interest rates. That's because credit scores are the equivalent of a financial report card. They show lenders how reliable someone is when paying back loans.

Before you start looking for a mortgage loan, make sure to check your credit report. You can get a free copy from one of the three major credit bureaus – Equifax, Experian, and TransUnion – once per year. If your credit report isn’t all rainbows and butterflies, here are a couple of ways to improve it:

• Pay your bills on time
• Pay off your debt
• Improve your credit utilization ratio
• Avoid hard credit checks

You should also dispute any inaccuracies on your credit report. Even small discrepancies, such as inaccurate personal information or a fraudulent account, can lower your credit score. While it will take time to correct the error, you will be better off in the long run.

Your Location

The cliché is true. Real estate depends on location, location, location. It affects everything from a home's value to the interest rate.

Lenders will offer different interest rates based on the state. For instance, borrowers in North Carolina can expect slightly lower rates than those in Nevada, all else equal. The best way to know how location affects your interest rate is to talk with multiple lenders.

Your Mortgage Loan

If your credit score has the most influence on your interest rate, your mortgage loan has the most ways to influence it. Put another way: mortgage loans are complex. Each part determines whether your interest rate goes a little bit up or a little bit down.

When you're reviewing your mortgage loans, here are some questions to ask:

WHAT TYPE OF MORTGAGE LOAN DO I WANT?

Conventional. Jumbo. VA. USDA. These are just a few of the different mortgage loan types.

Each loan type has distinct qualifications. For instance, USDA loans are for rural borrowers whose income does not exceed a certain level. Because they are intended for low and middle-income families, they tend to have lower interest rates than conventional loans. The important thing to know is that interest rates can vary greatly based on the loan type.

DO I WANT AN ADJUSTABLE OR FIXED INTEREST RATE?

There are two types of interest rates: adjustable and fixed. Fixed interest rates stay the same for the entire mortgage. Adjustable-rate mortgages (ARMs) increase or decrease based on the market. For instance, when the Fed cuts interest rates, ARM owners win. When Federal interest rates rise, though, they have to pay more.

ARM owners typically benefit from lower interest rates at the start. The adjustable interest rate is liable to increase significantly later on, which can make ARMs more expensive.

Learn more about fixed and adjustable rates with our mortgage rates calculator.

HOW MUCH CAN I PUT TOWARD A DOWN PAYMENT?

In general, the larger your down payment, the lower your interest rate. Conventional wisdom says to put down 20 percent of the home's value in the down payment. That percentage may vary based on your mortgage loan type.

A sizeable down payment lowers the overall cost of borrowing. That means you pay less for your home and can avoid paying private mortgage insurance. Plus, a 20 percent down payment makes you more attractive to sellers and lenders who want to minimize their risk.

HOW MUCH DO I WANT TO BORROW?

Unless you are Scrooge McDuck, the odds are you'll need to borrow money to buy a home. That amount is the house's price minus the down payment. Typically, the less money you have to borrow, the lower your interest rate. Depending on the mortgage loan process, you'll have to add in other expenses like mortgage insurance and closing costs.

WHAT IS THE IDEAL MORTGAGE LOAN LENGTH?

Most mortgage loans are 15 or 30 years, though some lenders offer 10- and 20-year options. Generally speaking, the shorter the loan, the lower the interest rate. On the one hand, a shorter loan means higher monthly payments. On the other hand, you pay off the loan faster and with less interest.

See how loan length affects your interest rate with our mortgage rate calculator.

Your Job Security and Future Expenses

When you finish paying off your mortgage, you'll be a different person than when you started. You’ll complete paying student loans (hopefully.) You’ll probably have a new car and a new career. You may even have a kid or two or three and have to worry about their student loans.

The point is that you have to factor in your future budget. In general, you earn more as you get older. At the same time, you have to consider new costs, like tuition, vacations, and medical treatment. A 15-fixed rate mortgage with an aggressive interest rate may not be as attractive after having kids or while caring for an aging parent. It all depends on your needs, preferences, and aspirations.

The Bottom Line

Lenders use multiple factors to determine interest rates, not just one. Some things, like your credit score, go back before you ever considered buying a home. While each borrower is different, it’s in your best interest (no pun intended) to factor in these components when looking at mortgage interest rates.

You have more control over some factors (location and down payment) than others (closing costs and Federal interest rate). Focus on what you can control and how it affects your overall mortgage. Taking the time to understand these factors now will help pay dividends down the road.