How Your Mortgage Interest Rate is Determined


Michael Idarola, Mortgage Expert
Posted July 16, 2021

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How Your Mortgage Interest Rate is Determined

If you are applying for a mortgage, you need to know what your budget is. The only way to figure out your budget is if you understand how your mortgage rate is calculated. Unless you plan on purchasing your house in cash, you need to apply for a home loan, which is called a mortgage. Your mortgage is going to play a significant role in your monthly payment, along with your homeowners’ insurance and real estate taxes.

There are three factors that go into your monthly mortgage payment. These include:

  • The interest rate on the home loan
  • The size of the home loan
  • The repayment period

Even though you are in total control of the size of the home loan and the repayment period, you are not in total control of the interest rate.

What factors determine mortgage rates?

There are many factors that affect the mortgage interest rates available in your market. Some are within your control and some aren’t, but with knowledge of these factors, you can feel more confident about getting a competitive interest rate when you apply for a mortgage.

Mortgage rate factors that you control

When you apply for a mortgage, lenders will assess your creditworthiness and set the rate they will loan to you accordingly. The higher their risk assessment of your application, the higher the interest rate that may apply to your mortgage.

Lenders are always concerned about your ability to pay back the loan and are basically evaluating the chances the borrower may default.

When deciding how much interest to charge on the home loan, mortgage companies consider three main factors: your credit score, your debt to income ratio and the loan-to-value ratio.

A good question to ask a lender is what your actual interested rate will be. Here are some of the factors that go into determining the actual rate you’ll get on your loan.

Your Debt to Income Ratio

Your debt to income ratio will also play a role in the interest rate attached to your mortgage. For example, if you have many other sources of debt such as credit card debt, a personal loan, a car loan, or student loans, the bank may hesitate to give you a mortgage on top of this. They might charge a higher interest rate for doing so. Consider paying back some of your other sources of that before you apply for a home loan if you would like a lower mortgage rate. 

Loan-to-value Ratio

The loan-to-value ratio measures the mortgage amount in comparison to a home’s value. Let’s say you make a $40,000 down payment on a $200,000 home. The mortgage will be $160,000. You’re borrowing 80% of the home’s value, therefore your loan-to-value ratio is 80%.

The more cash you use as a down payment, the smaller your loan-to-value ratio.

A loan-to-value ratio greater than 80%, is considered high and has a greater risk for the lender. The loan will usually require private mortgage insurance and will most likely have a higher interest rate.

Credit Score

Your lender will look at your credit score to evaluate how likely you are to pay back the loan. They will also look at your mortgage payment history and debt-to-income ratio. Generally, lenders are looking for a credit score of 620 or higher with no recent mortgage delinquencies on your record.

Home Price And Down Payment

Potential buyers with a lower loan-to-value ratio (LTV) will usually have more advantageous interest rates. The size of the home loan in relation to the total value of the property is typically indicative of its risk, and lenders will often offer better terms to buyers with more skin in the game.

Loan Type

Lenders offer different interest rates for different types of loans.  The mortgage interest rates for conventional loans are typically lower than those offered by FHA and VA loan programs. The mortgage interest rate is also affected by the term of the mortgage, which can range from 15 years to 30 years, as well as other factors including credit score.

Fixed-Rate vs. Adjustable-Rate Mortgages

What is a fixed-rate mortgage?

A fixed-rate mortgage is a mortgage loan with an interest rate that remains the same throughout the life of the mortgage. This means you’ll be paying back your mortgage in full and at all scheduled payments, over time, without any suspenseful fluctuations in monthly payments. The interest rate on these mortgages tends to be higher. The downside to this type of mortgage is that it generally costs more than an adjustable-rate mortgage (ARM) because lenders assume there’s less risk when they know what their customers’ total payment will look like for 30 years.

What is an Adjustable-Rate Mortgage?

An adjustable-rate mortgage, or ARM, is a mortgage with an interest rate that can change over time. This means your monthly mortgage payment could fluctuate from month to month as the underlying index changes. The interest rates on Adjustable Rate-Mortgages tend to start off lower and adjust over time. The upside of this type of mortgage is you’ll enjoy lower interest rates for a set period and then experience a gradual increase in those rates every few years until it reaches its endpoint (usually at 30 years).

The Current Economic Situation

Finally, the current economy is also going to play a role in your mortgage rate. The Federal Reserve controls the rate at which other banks lend money from them. If the Federal Reserve raises its interest rates, other banks will raise their interest rates as well. Because lenders have to borrow money at a higher interest rate from the Federal Reserve, they may charge you a higher interest rate as well. Keep track of how the overall economy is doing, so you understand what type of interest rates the Federal Reserve is charging. This will impact your interest rates as well. 

Understand Your Mortgage

These are just a few of the many factors that will play a role in the interest rate on your mortgage. If you have questions about how your interest rate is determined, you should reach out to a loan officer who can help you. That way, you know the interest rate for your specific scenario.


Hi, I'm Michael Idarola
Your Mortgage Loan Officer & Mortgage Expert.

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Your Mortgage Expert

I'm Michael Idarola

Hi, my name is Michael Idarola. I'm a Mortgage Expert with Premier Lending Inc., offering personalized mortgage or home loan solutions, customized mortgage quotes, great rates, and personalized service. I'd love the opportunity to help you get into a home you love with a home loan you can afford.