Factors Affecting Interest Rates

How Interest Rates Are Determined

Home loan lenders charge interest to customers that borrow money from them. The interest rates that home loan lenders can charge are determined, in part, by the monetary policy of the Federal Reserve Board (or Fed) a government-sponsored committee that monitors the nation’s economy and sets various interest rates to help control and manage it.

Rates vs. Payment

Mortgage payments can vary largely from one type of mortgage to another and the availability of rates vary from one borrower to another. Customers often shop for the lowest mortgage payment possible – an investment to fit their lifestyle and budget.

Key factors that can impact your mortgage payments include: principal, interest rate, points, taxes, insurance and credit quality. Generally, the better your credit score, the lower your mortgage rates and monthly payments are likely to be. If your credit history is less than perfect, your mortgage rates and payments may be higher.

Interest Rates Are Used to Calculate Your Payment

The interest rate on your home loan is used to calculate your monthly mortgage payment. Higher interest rates will yield a higher monthly payment. Lower interest rates will reduce your monthly payment. Simple? Yes, but it may be unclear until you see it applied to your loan.

Mortgage payments are different from one type of mortgage to another and from one borrower to another. Most people want a rock-bottom mortgage payment! When you’re shopping for a home loan, it’s important to understand what goes into determining the size of your payment and how you can impact that.

Lower Your Rate and Payment with Points

Points are fees paid to the lender at closing. Each "point" is equal to 1% of the loan amount. For a $100,000 loan, a point equals $1,000. Two points would be a $2,000 fee.

With many loans, you can lower the interest rate you receive by paying higher points. If you have the cash and plan on staying in the home long enough to cover the cost of paying the point(s), it's a good way to save money on interest over the life of your loan. If you're low on upfront cash or plan on moving or refinancing in the first few years, then it may be best to pay zero or lower points. See our Discount Points Breakeven calculator here.

Compare Loans Using the Annual Percentage Rate (APR)

Home loans are more than interest rates and points. They also involve other costs. The APR expresses the annual cost of a loan as a percentage, factoring in not only its rate, but the points and other charges over the life of the loan.

The Truth-in-Lending law requires all advertisements for home loan credit terms to include the APR. The APR is intended to enable you to compare terms of loan products from different lenders. To make an accurate comparison, compare loans with the same terms, interest rates and points. Then look at the APR. The loan with the lower APR is the less expensive loan.

Fixed-Rate Mortgages and Interest Rates

Fixed-rate mortgages carry a stable interest rate that can provide peace of mind with stable and unchanging monthly payments over the life of the loan.

When you get a fixed-rate mortgage, you’ll enjoy a predictable monthly payment that will not increase or decrease over the life of the loan.

ARMs and Interest Rates

The interest rate on an adjustable rate mortgage (ARM) changes over time, depending on the terms of your loan. ARMs usually offer a low introductory interest rate and lower mortgage payments at the beginning. ARMs typically adjust every 6 or 12 months, depending on the index on which it is based and market conditions.