A mortgage rate is the rate of interest charged on a mortgage. Mortgage rates are determined by the lender and can be either fixed, staying the same for the term of the mortgage, or variable, fluctuating with a benchmark interest rate. Mortgage rates vary for borrowers based on their credit profile. Mortgage rate averages also rise and fall with interest rate cycles and can drastically affect the homebuyers' market.
Breaking Down Mortgage Rate
The mortgage rate is a primary consideration for homebuyers looking to finance a new home purchase with a mortgage loan. Other factors also involved include collateral, principal, interest, taxes, and insurance. The collateral on a mortgage is the house itself, and the principal is the initial amount for the loan. Taxes and insurance vary according to the location of the home and are usually an estimated figure until the time of purchase.
Mortgage Rate Indicators
There are a few indicators potential homebuyers can follow when considering a mortgage loan. The prime rate is one indicator. This rate represents the lowest average rate banks are offering for credit. Banks use the prime rate for interbank lending and may also offer prime rates to their highest credit quality borrowers. The prime rate typically follows trends in the Federal Reserve’s federal funds rate and is usually approximately 3% higher than the current federal funds rate.
Another indicator for borrowers is the 10-year Treasury bond yield. This yield helps to show market trends as well. If the bond yield rises, mortgage rates typically rise as well. The inverse is the same; if the bond yield drops, mortgage rates will usually also drop. Even though most mortgages are calculated based on a 30-year timeframe, after 10 years, many mortgages are either paid off or refinanced for a new rate. Therefore, the 10-year Treasury bond yield can be an excellent standard to judge. You can use Investopedia's mortgage calculator to estimate monthly mortgage payments.
Determining a Mortgage Rate
A lender assumes a level of risk when it issues a mortgage, for there is always the possibility a customer may default on his loan. There are a number of factors that go into determining the mortgage rate, and the higher the risk, the higher the rate. A high rate ensures the lender recoups the initial loan amount at a faster rate in case the borrower defaults, protecting the lender's financial investment.
The borrower's credit score is a key component in assessing the rate charged on a mortgage and the size of the mortgage loan a borrower can obtain. A higher credit score indicates the borrower has a good financial history and is more likely to repay his debts. This allows the lender to lower the mortgage rate because the risk of default is lower. The rate charged ultimately determines the overall cost of the mortgage and the amount of the monthly payment. Therefore, borrowers should always seek the lowest rate possible.