Here Are 7 Factors That Can Affect Your Mortgage Rate

Here are the most important points to take away from this guide:

• Mortgage rates can be influenced by many overlapping factors.
• Your credit score and the type of loan you choose will affect your rate.
• Lenders use risk-based pricing when making such decisions.
• Borrowers who bring more risk usually pay more in interest.
• You could get a lower interest rate by lowering your risk factors.

Many home buyers already know that credit scores can influence the mortgage rate they receive from a lender. That much is true. But it’s just one piece of a bigger picture.

The truth is there are many factors that could influence the interest rate on your home loan. These include your credit score, the type of loan you choose, the size of your down payment, and whether or not you use discount points.

How Mortgage Lenders Price Their Loans

Mortgage interest rates are not standardized across the industry. They actually vary from one lender to the next and, more to the point, from one borrower to the next.

Lenders set their mortgage rates in order to offset the risk of borrower default (or failure to repay), and also to make some profit on the loan. It is a business, after all.

They also price their loans to remain competitive in the market, against other lenders. For instance, if a mortgage company wanted to attract more borrowers, it could simply offer lower mortgage rates and fees than its competitors.

7 Factors That Affect Your Mortgage Rate

Let’s take a deeper dive into some of the specific factors that could affect your mortgage rate when shopping for a home loan.

1. Risk-based pricing.

Risk is one of the primary factors that influence mortgage pricing and fees. Banking and lending are risky businesses. There’s always a chance the borrower will fail to repay his or her debt obligation down the road, which is known as “default.”

Riskier borrowers are often charged higher interest rates than less risky borrowers. Which begs the question: How do lenders actually measure risk from one borrower to the next?

One of the tools they use is your credit score. So let’s talk about that next.

2. Your credit score.

Credit scores are three-digit numbers. They are based on the information found within your credit reports, which can include all kinds of information from your borrowing history.

If you tend to pay all of your bills on time and maintain relatively low credit card balances, you probably have a good credit score. On the contrary, people who routinely make late payments — or skip payments altogether — tend to have lower scores.

Mortgage lenders use credit scores for risk analysis, among other reasons. A borrower with a high (good) score is viewed as a lower risk, while a person with a low (bad) score is seen as a bigger risk. So this three-digit number is one of the major factors that can affect your mortgage rate.

Here’s a simpler way to think about this relationship:

• Great credit: low risk and most favorable pricing
• Decent credit: medium risk and favorable pricing
• Poor credit: high risk and least favorable pricing

The best way to maintain a good credit score is by paying all of your bills on time. This includes car payments, credit cards, student loans, personal loans, and the mortgage itself.

Limiting your “credit utilization ratio” can also help maintain a good score. The utilization rate is the sum of all your balances divided by the sum of your cards’ credit limits.

3. The size of your down payment.

The amount of money you are willing to put down on the loan can also influence your interest rate. And once again, it comes down to a matter of risk.

Making a larger down payment results in a lower loan-to-value (LTV) ratio, which also reduces the level of risk exposure for the lender. On the contrary, a smaller down payment results in a higher LTV, and could therefore result in a higher mortgage rate.

Generally speaking, home buyers who make a bigger upfront investment tend to qualify for more favorable pricing — and vice versa.

Here’s an in-depth explanation of the relationship between down payments and mortgage rates.

4. The type of home you’re buying.

Different types of properties have different risk levels associated with them, based on the historical likelihood of default. So, by extension, the type of property you are buying can also affect the interest rate on your home loan.

Generally speaking, single-family homes that are purchased as a primary residence pose the lowest risk of default. Properties purchased as vacation or second homes tend to have a higher default rate.

Lenders often charge higher rates for riskier properties, along with stricter underwriting guidelines.

5. The amount of money you’re borrowing.

Larger loans are riskier than smaller ones, for the simple fact that there is more money involved and therefore a higher potential for loss.

As a result, borrowers who use conforming loans (which meet the size restrictions used by Freddie Mac and Fannie Mae) often qualify for lower mortgage rates than those who use jumbo loans (which are too big to be sold to Fannie or Freddie).

Higher loan amounts often require a larger down payment, as well.

6. Whether or not you pay “points” at closing.

Did you know you can secure a lower rate on your mortgage loan by paying a little more money up front, at closing?

This is a common strategy used by borrowers who want to minimize their long-term interest costs (and don’t mind paying higher closing costs to achieve that goal).

A discount point is a form of prepaid interest. One point will cost one percent of the loan amount and typically reduces the mortgage rate by around 0.25%.

Like many things lending-related, this strategy involves a trade-off. You’re paying more money up front, as part of your closing costs. But you’ll pay less in interest over time — possibly a lot less.

Paying points works best when a borrower plans to stay in the home and keep the loan for more than five years. But the “break-even point” can vary, so you’ll want to have your lender calculate it for you.

For more on this subject, check out our in-depth tutorial on discount points.

7. Shopping around for the best deal.

Different lenders offer different rates, based on their business models and their appetite for risk. That’s why it’s important to get more than one offer before locking in your home loan.

A few years ago, a Stanford University study showed that mortgage shoppers who got at least three quotes from lenders saved thousands of dollars on a $200,000 home loan.

Here’s a quote from the report:

“Given this conclusion, we ask what benefit a borrower who shopped from only two brokers passed up by not shopping from three or four. The answers are so large that we believe that most borrowers must have been unaware of the likely benefits of more shopping. For example, for a mortgage with $100,000 principal, a borrower would save a median of $981 by adding one more broker to the mix and $1,393 by adding two. And with $200,000 principal, the savings are $1,866 and $2,664.”

So there you have them, seven factors that can influence your mortgage interest rate. Granted, these are not the only factors that come into play during the pricing process. But they are some of the most influential.

The bottom line is that it pays (literally) to shop around. Get quotes from different lenders, and ask them why you are being offered a certain rate. Ask what you can do to secure a lower rate on your loan, such as paying discount points. A reputable lender will take the time to sit down with you and explain your options.