Have you ever wondered how lenders determine the interest rate for your mortgage? There are many factors that affect your mortgage rate, some of them within your control and some of them decidedly outside it. The world economy, the prime lending rate set by the Federal Reserve and prevailing local interest rates all have an effect on the interest rates that lenders are willing to extend to borrowers, but those factors mostly establish a starting point. From there, lenders will take your credit history and a number of other factors into consideration to adjust their base rate and come up with a mortgage rate that reflects the amount of risk they take in lending to you. These are some of the biggest factors that lenders use in determining your mortgage rates.

The type of mortgage affects the mortgage rate that you’re offered.

Historically, the initial rates on adjustable rate mortgages were lower than those offered on fixed rate mortgages. The recent subprime mortgage crisis has affected that somewhat, and for the past couple of years, adjustable rate mortgages carry slightly higher mortgage rates to offset the additional risk that lenders take on with customers who take out adjustable rates.

In addition, jumbo ARMs – mortgages for more than $417,000 – also tend to carry slightly higher interest rates than traditional mortgages. In fact, the amount of money that you borrow affects the mortgage rate that you’re offered. Generally, larger mortgages carry higher interest rates.

The less risk for the lender, the lower the mortgage rate you’ll be offered.

Since the interest rate you’re offered reflects the amount of risk the lender believes he takes in lending to you, anything that makes you a less risky borrower will lower the interest rate you get on your mortgage. Those risk factors include:

• Down payment amount. The more equity you have in your property, the less chance there is that you’ll default on your mortgage. If you can put down at least 20% of the home price as a down payment, you’ll have a good chance of qualifying for the lowest mortgage rates.
• Home value to loan ratio. The loan-to-value ratio, or LTV, is a second determinant of the interest rate you may be offered. The higher the LTV, the more risk the lender assumes and the higher the interest rate on your loan. For instance, if you want to borrow $85,000 to buy a $100,000 home, the LTV is 85%. In general, an LTV of less than 80% will give you the lowest interest rates.

Your credit score is a major determinant in deciding your mortgage rate.

Your credit score is calculated using a combination of your credit history and other personal information. Among the factors that affect your credit score are:

• how many credit cards you have
• how long you’ve been using credit – the longer the better, in general
• whether you pay your bills on time and according to agreements you make
• the ratio of your debt to available credit
• your marital status
• how long you’ve been working in your current position
• how long you’ve lived at your current address
• whether you rent or own a home
• how many jobs and residences you’ve had in the past ten years

The type of property you’re buying plays a part in determining your mortgage rate.

In addition, lenders will take the type of property you’re buying into account when determining the interest rate on your loan. Because people are least likely to default on mortgage payments on their primary residence, first mortgages on a primary residence will usually qualify for lower interest rates than investment properties. Commercial real estate carries even higher interest rates than residential properties.

Other factors that affect mortgage interest rates

Besides those individual factors, interest rates are also affected by location. Mortgage rates vary from state to state, city to city and even from neighborhood to neighborhood. Lenders rely on historical data to help them determine the risk of lending money to purchase a home or other property in various communities, and that risk is reflected in the interest rate they charge for a mortgage in those communities.

In general, you can expect the best interest rates if you have an excellent credit rating, can put down at least 20% as a down payment, and are buying a primary residence. Don’t forget, though, that different lenders have different standards for determining interest rates. Make it a point to get several quotes from various lenders when you’re looking for a mortgage in order to get the best deal possible.

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