We all want the lowest interest rate possible when buying a new home, right? I mean, you could be paying that interest for 15-30 years, depending on your loan term. That’s why “what will my interest rate be?” is one of the most popular questions for mortgage applicants.
If you are like me and most other readers, and might get distracted and stop reading soon, take away these three things:
Now, if you really want some good information, keep reading!
1. What an Interest Rate Costs – Pricing and Discount Points
What many buyers do not know is that you can generally select the interest rate you want. What will change is how much that interest rate will cost.
The discount point is an essential term in selecting your interest rate. A discount point is what you will pay to “buy” your interest rate. Discount points are calculated as follows:
1 discount point = one percent of your loan amount
So, if you have a $100,000 loan, one discount point would equal $1,000.
Every interest rate has an associated discount point (i.e. price). But, it’s usually a decimal, rather than a whole number. For instance, a particular interest rate might have a price of .250. This means that interest rate would cost .25% of the loan amount, or, $250 for a $100,000 loan. Generally speaking, as the interest rate goes up, the cost goes down. A “par rate” is an interest rate that has 0.0 discount points. For interest rates higher than the par rate, you would receive a credit rather than pay a cost. For instance, a particular interest rate might have a .250 credit associated with it. That means you would actually receive a $250 credit at closing. That amount is subtracted from your cash to close number.
So, the right question when it comes to selecting your interest rate really is this: how much will it cost to get the interest rate that I want?
Once you understand the different pricing for different interest rates, you can then analyze which rate is best for you based on how much you would have to pay for the rate. If you plan to live in the house for 30 years and you want the lowest possible total payments over than time period, you may want to pay a higher discount for a lower interest rate. On the other hand, if you are buying your first home and are not likely to own the home more than a few years, you may want to get a slightly higher interest rate with a lower cost, as you will not be making payments long enough to make up the difference.
The time you plan on remaining in that home is one key factor in determining which interest rate is right for you. Another key factor is your available money. If you only have a certain amount of money available for down payment and closing costs, you will need to limit the costs of your loan, which you can do by selecting a higher interest rate and paying a lower discount point. One additional note to be aware of is that federal guidelines restrict loans known as “high cost” loans. This means that the cost associated with getting your loan cannot exceed a certain percentage of your loan amount. For this reason, you will also have limits on the amount you can pay to lower your interest rate.
2. Credit Score
You probably already know that your credit score is very important when it comes to getting a mortgage loan. Your credit score is the primary driving factor when it comes to determining what the cost will be for a particular interest rate.
Here’s what you should know: There are typically certain score “thresholds” where the pricing improves for interest rates. For instance, the pricing might be the same if your score is 650 – 679, but might improve if your score is 680.
Why is that important? Well, the first thing you will do when you apply for a mortgage is have your credit pulled. If your loan officer tells you that your qualifying score is 678, an important question would be, “would pricing improve if I increased my score to 680?” Again, the answer to this question is often (but not always) yes.
Of course, the general is the higher your score, the better the pricing. It is important to understand that improving your credit score is almost always the best way to get a better interest rate without a higher cost. But, it’s also important to understand that a higher credit score does not always mean a better price. The pricing typically will only improve at those “thresholds” set by the lender for their particular interest rate.
If you are considering spending significant amounts of money on credit repair prior to applying for a mortgage, it might be beneficial to first find out 1) what is current pricing at your current score, 2) what would pricing be at your target score, and 3) how much money would it save you.
Note that this article is not about qualifying scores, but you should keep in mind that you typically need at least a 600+ score to qualify for a FHA loan (technically 580 qualifies, but you will find most lenders require 600), 620+ for a conventional loan, and 640+ for a USDA loan. If your qualifying score is below those numbers, you will want to see how you can improve your score before applying for a mortgage.
Lastly, you should know that your “qualifying” score is the middle score reported by the three major credit bureaus (Equifax, Transunion, Experian). Unless you have seen your most recent score from each of those three bureaus, you may not have an accurate number for your qualifying score.
3. Price changes.
If you are still reading, you probably have looked into interest rates enough to know that they constantly change. What you may not have known before, and hopefully understand now, is that is not really the rate that is changing, but the price for that rate. When you hear that rates went up or rates went down, that means that the discount point, or price, associated with a particular interest rate went up or down.
Of course, this is kind of the “bad news” when it comes to determining your interest rate. It means that you cannot be sure what the price for your interest rate will be on any given day, and when you get a rate quote, it is always subject to change.
This is important to understand, because you have probably seen advertisements from lenders all over the place, and may have checked “current interest rates” online. These advertisements will always be based on a particular credit score, and will have an associated discount point.
4. What does all of this mean?
The important takeaway is this: if you want to know what interest rate is best for you, you need to know what your qualifying credit score is, and what the current price is for the interest rate you want given your score. From there, you will be able to determine what interest rate works best for you.
You can always contact us to find out more!
Davis Love Pathway Mortgage (864) 814-0710 firstname.lastname@example.org