A mortgage is a type of loan that allows you to finance a home. The home you're purchasing serves as collateral for the loan. If you fail to make your monthly mortgage payments, the lender has the right to take the home back through a foreclosure process. Most mortgages are amortized over a certain number of years, such as 15 or 30, and you'll pay interest on the loan in addition to making payments on the principal amount. The interest rate and loan term work together to determine your monthly mortgage payment.
Here's how it works: Let's say you borrow $200,000 at a 4% interest rate. The interest rate is the cost of borrowing the money, expressed as a percentage of the loan amount. In this example, it would cost you $800 per month in interest to borrow that $200,000 at 4% (that's 4% of $200,000). Over the life of the loan, you'd pay almost $48,000 in interest alone.
The loan term is the length of time you have to pay off the loan. In the example above, you might have a 30-year mortgage. That means you'll make monthly payments on the principal for 30 years. You could opt for a 15-year mortgage, which would mean larger monthly payments but less time paying interest. A 30-year mortgage would mean lower monthly payments, but you'd pay more in interest over the life of the loan.
Your monthly mortgage payment is the combination of your interest payment and principal payment. As you pay down the principal, more of your monthly payment goes toward interest and less toward the loan balance. When you're making a 30-year mortgage payment, more of it goes toward interest. As you pay down the loan, more of your payment goes toward principal.
How to get a mortgage The mortgage process typically begins with getting pre-approved for a loan. During this step, the lender will review your financial information and credit history to determine how much they're willing to lend you. With a mortgage pre-approval in hand, you can start house hunting. When you find a home you like, the lender will recheck your financial situation and the home's details to finalize the loan.
To get a mortgage, you'll typically need a good credit score and a steady income. Lenders consider several factors when deciding whether to approve your mortgage application. These include:
Debt-to-income ratio. How much you owe each month compared to your gross income
Employment history. How long you've been with your current employer and in your job
Savings. How much you have for a down payment and how much you can afford for a monthly mortgage payment
Credit history. Your credit score and any late payments or other negative marks on your credit report
If you're a suitable risk, the lender will approve your loan and you can move forward with the mortgage process. You'll work with your lender to finalize the details of your loan and prepare for the costs of homeownership.
Your monthly mortgage payment is made up of two parts: paying back the principal loan amount and paying interest on the loan. When you first get a mortgage, most of your monthly payment goes toward interest and a small amount goes toward the principal loan balance. As you pay down the loan, more of your monthly payment goes toward the principal and less toward interest.
If you decide to sell your home before paying off the mortgage, you can use the sale proceeds to pay off the loan. If you don't have enough equity in the home to pay off the entire mortgage, you'll be responsible for the difference when you sell. You could also consider buying the new home with a new mortgage and adding the old mortgage to the new one. This is called "rolling" the mortgage.
What affects mortgage rates?
It's helpful to understand what can make mortgage rates rise or fall. This is especially important to know if you're considering an adjustable-rate mortgage, since those loans are tied to the mortgage market. Several factors influence mortgage rates:
Inflation. Inflation erodes the value of money, which means lenders need to charge more interest on mortgages to make their returns grow. To offset inflation, lenders charge higher interest rates when inflation is high. Generally, when inflation rises, mortgage rates follow.
Gross Domestic Product (GDP) and Employment. A strong economy and rising wages mean people are spending more money. When incomes rise, so does the demand for homes. To capitalize on this, lenders offer lower rates to encourage borrowing. If average incomes fall, lenders may offer slightly better rates to stimulate borrowing.
Federal Reserve policy. The Federal Reserve, not to be confused with the Federal Reserve Bank, influences interest rates through monetary policy. The Fed doesn't set mortgage rates, but it does control the federal funds rate and the amount of money in circulation, which affects the entire mortgage market.
Bond market performance. Mortgage-backed securities (MBS) are sold to investors on the bond market. Lenders need to offer attractive returns to investors to make up for the low yields on MBS. If MBS prices fall, lenders may need to offer higher rates to make their mortgages more attractive. If the bond market is hot, mortgage rates may rise to compensate.
Housing market. The relationship between the number of homes available and the demand for housing impacts mortgage rates. If there's a low supply of homes for sale, it can drive prices and rates higher. On the other hand, if more people rent than buy, the demand for mortgages might be lower, and lenders may offer slightly better rates to entice borrowers.
How to compare mortgage rates
When shopping for a mortgage, comparing mortgage rates is crucial. The interest rate you're offered will greatly impact your monthly mortgage payment and the total cost of the loan. Here's a step-by-step guide to comparing mortgage rates:
Determine your budget. Before comparing rates, decide how much you can afford to spend on a home. This will help you determine how much you can borrow and which loan types are suitable for your situation.
Learn about different mortgage types. Familiarize yourself with the main types of mortgages: fixed-rate, adjustable-rate and government-backed loans. This will help you understand how different mortgage options impact your monthly payments and overall costs.
Get quotes from multiple lenders. Just because your friend Mike had a good experience with his lender doesn't mean you should automatically go with the same lender. Do some research and get quotes from several lenders. Online rate comparison tools can be helpful.
Consider more than the rate. The interest rate is the main factor to consider when comparing mortgage rates, but it's not the only thing. Lenders may offer different loan terms, origination fees, discount points and other costs that can impact your mortgage costs. Make sure to factor these in when comparing lenders.
Negotiate. If you've gathered a few quotes, use that information to negotiate with lenders. If one lender won't budge on rate, try negotiating other loan terms, such as lower fees or a longer loan term.
Consider the bigger picture. A lower interest rate might be enticing, but consider the long-term effects. A higher rate might mean a shorter loan term and higher monthly payments, but you'll save thousands more in interest over the life of the loan.
By comparing mortgage rates and weighing these factors, you can find a mortgage that fits your budget and lands a great deal on your home loan.
What are current mortgage interest rates?
Recent data from Freddie Mac shows mortgage rates continuing to rise, with six straight weeks of increases. The average 30-year fixed mortgage rate has more than doubled from last year and now sits at 6.942%. The average 15-year fixed mortgage rate has increased 2.15 percentage points from last year and now stands at 5.717%. The 5/1 adjustable-rate mortgage (ARM) average rate has jumped 2.8 percentage points from last year and now is at 5.3%. Mortgage rates are experiencing the fastest growth in four years.
The increased mortgage rates have pushed the typical family's monthly mortgage payment to nearly 25% of their income. Along with soaring home prices, this has contributed to a softening in homebuying demand. Real estate experts predict home prices will level off, but the national average monthly mortgage payment will remain high in 2023.
How to get a mortgage with a good rate
To shop for a mortgage effectively and get a good rate, it's important to understand the difference between the interest rate and the annual percentage rate (APR). The APR includes your mortgage's associated costs, such as: closing fees, loan origination charges, property taxes, private mortgage insurance and homeowners insurance.
Credit score. A good credit score is necessary to qualify for good mortgage rates. Most mortgages require a minimum 620 credit score, but you'll qualify for the best rates with a score of 760 or higher.
Debt-to-income ratio. Keep your debt-to-income ratio low. Your DTI ratio should be 36% or less. A higher ratio might mean you're offered less favorable mortgage rates, and some mortgage products, like FHA loans, can allow for a DTI up to 43%.
Stable employment. You'll increase your chances of getting good mortgage rates by showing at least two years of stable employment. Consistency is key, and self-employed borrowers may need to provide additional paperwork to help their mortgage applications.
Down payment. The amount you put down can impact your interest rate. A larger down payment means a smaller loan amount, which could net you a lower rate. Different types of mortgages, like FHA loans, have different down payment requirements.
Choose fixed-rate mortgages. Fixed-rate mortgages offer predictability, as the rate is locked in for the life of the loan. Adjustable-rate mortgages may start with a lower rate, but can change with the market.
Refinance. Refinancing can be a good way to get a lower interest rate and reduce your monthly payment. A 15-year fixed-rate refinance is often the best way to refinance, as you'll pay off your loan faster and save money on interest.
By following these guidelines and doing your homework, you can shop for a mortgage with confidence and land a great rate on your home loan. Mortgage rates can change quickly, so it's important to stay informed and compare loan offers from multiple lenders.