Everything you need to know about mortgage interest rates, including how much you’ll pay

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Mortgage Interest Rate Calculator
Mortgage interest can significantly increase your monthly payments.

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Interest is the cost you pay to borrow money. And while it’s only a portion of your monthly mortgage payments, it can often add up to significant costs over time and affect how much mortgage you can afford. Understanding how your mortgage interest rate is calculated is a crucial step in getting a home loan.

Here’s what you need to know about mortgage interest, how it’s calculated and how it affects your finances.

Will the Fed rate hike affect mortgage rates?

The Federal Open Market Committee sets the short-term interest rate — the federal funds rate — that banks use to borrow money. The fed funds rate does not directly affect long-term rates such as mortgages, but both tend to move in the same direction.

A day after the Fed’s last rate hike, mortgage rates rose to 5.78% for a 30-year fixed-rate mortgage and 4.81% for a 15-year. Freddie Mac said the 30-year rate hike marked “the biggest one-week increase in our survey since 1987”, adding that the higher rates are “the result of a change in expectations about inflation and the course of monetary policy”.

You can see what type of mortgage rates you currently qualify for using free online tools from a loan market.

Jacob Channel, senior economic analyst for LendingTree, says CBS MoneyWatch that rising rates could slow home sales as consumers wait for rates to drop.

“These high rates have significantly dampened borrowers’ desire to refinance their current loans, and they also show signs of reduced demand for purchase mortgages,” Channel added.

5 factors that affect your mortgage rates

Mortgage payments consist of two parts: principal and interest payments. Principal is the part of your payment that goes directly to your balance, while interest is the cost of borrowing money. Your home loan balance and mortgage interest rate determine your monthly payment.

Mortgage rates can vary widely from borrower to borrower. Indeed, mortgage lenders base them on a multitude of factors, including:

1. Credit score: Generally speaking, the higher your credit score, the better your mortgage rate. Lenders generally reserve their lowest rates for borrowers with 740 credit scores or better, according to documents from mortgage giant Fannie Mae.

2. Deposit: A larger down payment means the lender has less money at stake. Lenders generally reward a large down payment with a lower interest rate. Small installments are riskier and come with higher rates.

3. Loan program: There are many types of mortgages, and some offer lower rates than others. A VA loan, for example, typically has the lowest interest rate, though it’s only available to veterans, military service members, and surviving spouses. An FHA loan may offer a lower down payment and credit score, but is only available to first-time home buyers.

4. Type of loan: You can choose a fixed rate mortgage or an adjustable rate mortgage. With adjustable rate loans, your interest rate starts out low but can increase over time. Fixed rate mortgages usually have slightly higher rates, but they are constant for the life of the loan.

5. Duration of the loan: Mortgages come in different terms – or terms. A short-term loan usually has a lower interest rate than a long-term home loan. For example, in 2021, the average annual interest rate on a 30-year fixed rate was 2.96% and 2.27% on 15-year loans, according to Freddie Mac.

The economy and overhead, risk appetite and capacity of each mortgage lender will also play a role. (A lender with lower overhead can usually offer a lower rate). These factors mean it’s essential to shop around for multiple lenders when applying for a mortgage. Freddie Mac estimates that getting at least five quotes can save you up to $3,000 over the life of your loan.

How to Calculate How Much Interest You’ll Pay on a Mortgage

Mortgage interest is calculated in arrears, ie for the month preceding the date of your payment. When applying for your mortgage, your lender should provide you with an amortization schedule, which shows how much you’ll pay in principal and interest for each month of your loan term.

At the start of your loan, more of your payment will go to interest. You will pay more towards your main balance as you progress through your term.

What can cause your interest rate to vary?

If you get an adjustable rate mortgage (ARM), your interest rate and monthly payment may change.

With these loans, your interest rate is fixed for an initial period of three, five, seven or ten years. Once this time has elapsed, your rate increases or decreases according to the market index to which it is linked.

Adjustable rate mortgages typically come with rate caps, which limit your rate increase initially, annually and over the life of your loan. These caps can vary by lender, so it’s important to compare a few different companies if you’re considering a variable rate mortgage.

How to determine your mortgage rate and monthly payment

To determine your mortgage rate and monthly payments, you will need to obtain pre-approval from a mortgage lender. They will pull your credit score and ask you for details regarding your finances and home purchase.

Within a few days, you’ll receive a loan estimate, which will break down your estimated loan amount, mortgage rate, monthly payment, and other loan-related costs. You can use this form to compare quotes from multiple lenders and ensure you get the best deal.

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