The 6 Main Factors That Determine Your Mortgage Rates

Understanding your mortgage rate

Chris Clasby

Chris Clasby

Mortgage Professional

Ever wonder why rates posted online say, “as low as” or there’s an asterisk* next to the ad? Ever wonder why? The reason is that you almost definitely don’t qualify for that rate, and neither does anybody else! 

It’s click-bait. 

Today, we’re going to give you an honest, accurate analysis of what goes into interest rate qualification for your unique scenario, so you can find you the best possible rate (with us!) that you DO qualify for, and that won’t cost you a fortune at the closing table.

So what exactly is the “pricing” of an interest rate? Simply, it the cost to obtain particular terms on your home loan: interest rate, number of years to maturity, fixed or adjustable etc. all have a cost which is based on your unique scenario. Depending on the rate chosen sometimes there is no cost, and instead, a credit/rebate from the lender (which we’ll discuss as well!)

Below are the 6 major factors that go into the pricing of your home loan.

1) Loan Program

There are a lot more home loan programs out there than you would think, and every loan program will have different base rates associated with them.

Here’s a shortlist of some common and not so common loan programs:

  • Conventional Loans (Fannie Mae and Freddie Mac)

  • Federal Housing Administration Loans (FHA)

  • Veterans Affairs loans (VA)

  • U.S. Department of Agriculture Loans (USDA)

  • Jumbo Loans

  • Bank Statement Loans

  • Debt Service Coverage Ratio (DSCR) Loans

  • Interest-Only Loans

  • Reverse Mortgages

  • Stated income Loans

  • Asset/Portfolio-based Loans

  • Construction Loans

  • Commercial Loans

Conventional loans are the most common: you’ve got a job, a reasonable down payment of 5-20% of the purchase price, and you’re buying a home as your primary residence (not as a rental property). Other common options are FHA loans (great for first-time buyers!), or VA loans for veterans. We do all types, but the key is to make sure that the product fits your unique needs.

So what are these other programs? Well, if you don’t fit in the Conventional, FHA, or VA “box” there is probably a loan program that best fits your situation, and which you may not even know about! 

The best way to find out what will work for you is to work with one of our dedicated Mortgage Professionals.

2) Credit Score

Needless to say, credit score is the biggest factor that goes into the pricing of an interest rate for ANY loan program. Most lenders will go by 20 point “tiers”, for example, 660-679 is its own tier and all scores within that range will be treated equally. Then 680-699 will be the next “tier” with slightly better pricing on the interest rate, and so on and so forth up to 820.

While credit is a major factor, we can work with scores down to 500 which can often be a great way to get your debt situation fixed and lower your monthly payments. If you’re concerned about your credit score, give us a call, we can help!

3) Equity Position / Loan-to-Value Ratio (LTV)

The next biggest factor that goes into the pricing of an interest rate is the loan-to-value (LTV) ratio. 

Let’s do an example:

Say the balance of your current mortgage is $400,000 and the property value is $500,000. Because $400k is 80% of the $500k property value, the loan-to-value ratio is 80%, and you, the borrower, have 20% equity. 

Likewise, if you’re buying a home, again, say the property is worth $500k and you want to make a $50k down payment. What is the LTV? Well, because $50k is 10% of the $500k value, the loan amount is $450k and therefore the LTV is 90%.

Make sense? The key is the higher the LTV number the less equity (ownership) you have of the house, and therefore the more money you need from the lender, and more risk that the lender is taking on.

Because of this additional risk with a higher LTV, most lenders will adjust the pricing of the interest rate at increments of 5%, with pricing getting worse as the LTV increases. So, low LTV ratios of 50% to about 65% will often have the best rates, while higher LTVs of 80% to 95% will be more expensive.

4) Occupancy and Legal Structure of Real Estate

For residential properties, there are three occupancy categories: Primary Residence, Investment Property and Second Home. 

Interest rates are always going to be the lowest on your primary residence because you’re less likely to stop paying the mortgage on the place where you sleep at night. 

Investment Properties which generate income through rent, will always come with slightly higher interest rates (costs money to make money, right?!?). 

A Second Home can be a vacation home that goes unrented throughout the year, or simply a home that you live in for less than half of the year. The key is that it doesn’t generate income. Perhaps you work back and forth between two different cities and want to own a home in each city? That would qualify as a Second Home!

For residential properties, there are four main legal structure categories. Single Family Residences (SFR’s), Condos, 2-4 Unit Properties (also called, Multi-Family Homes), and manufactured homes. These different legal structures will all have slightly different pricing on the interest rate associated with them, with SFR being the most favorable. 

Fun fact: you can own a 2-4 Unit Property, live in one unit, rent out the other unit(s) and the rate will still be priced as a Primary Residence! (Maybe it doesn’t cost money to make money after all!). 

Finally, the odd duck: Manufactured Homes, which can actually be SFR, Condo, or not even Real Estate at all. The key is that the LAND (not just the structure!) must be owned by you, and the home must be permanently affixed to the land (meaning it has a foundation). So, you cannot rent a space from a mobile home park and get conventional financing (despite owning the home itself) because the land doesn’t belong to you.

5) Debt-to-Income Ratio (DTI)

Oftentimes, some of the more non-traditional loan programs will have a “pricing hit” at higher debt-to-income ratios, usually 43 or 45%. Higher DTI’s on conventional loans usually do not have a direct hit to the interest rate, but instead will require a minimum of 6-months of PITI (principal, interest, property taxes, and homeowners insurance) in reserves if the DTI is above 45%.

The maximum allowable DTI for conventional loans is 50% per Fannie Mae guidelines, but certain programs can go as high as 65%. Other programs don’t even use a DTI ratio but are more strict on LTV and credit score requirements.

6) Rate Lock Period

Another factor that goes into the pricing of the rate is how long you would like to lock the rate for. The most common rate lock period is 30 days, but 15, 45, 60 are also typically available. Some lenders will even go as long as 90 days. 

The longer the lock period, the higher the price of the interest rate, because the lender has to guarantee that they will be happy with that rate even if the market changes over a longer period of time. If you’re purchasing a property that is under construction that is scheduled to be completed in 75-80 days, and you think interest rates are going to go up in the near future, then a 90 day lock period could very well be in your best interest! However, because of the pricing hit, some people will wait to lock on 30 or even 15 days with the understanding that market changes may mean they pay a bit more despite the shorter lock period. 

Paying a small price for that longer lock period could end up saving you thousands over the life of the loan! Conversely, if you think interest rates will go down a bit in the near future, then you can start the application and underwriting process without locking the rate, and wait until a time closer to the close of escrow, and lock it for a shorter period.

This is where our role as Mortgage Professionals comes into play...

Based on your goals, we will match you up with the Wholesale Lender who will get you the best rate for your scenario. 

For example, one lender might favor higher equity more than excellent credit, whereas another lender might have the credit score weighted higher than the equity. One lender might have killer pricing on investment properties with 700+ FICO’s, while another might cater to FHA loans for first-time home buyers. 

With our network of lenders, it is a matter of getting to know you and your goals so we can advocate for you, while more direct lenders and banks are locked into only what they know.

These six major factors that go into the pricing of an interest rate are essential to understanding the loan process, however you don’t need to be an expert to take advantage: you need to WORK with an Expert. Get in touch today and let us show you what you EXACTLY what you qualify for without the click bait. 

Want to learn more? Click here to get in touch with Mortgage 101!

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