Average Interest Rate

    Average Interest Rate: Getting The Best Rate For Your Home

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    When taking out a mortgage for your new home, one of the most important things is its mortgage rate. This will determine how much you pay with each mortgage payment and can be influenced by numerous factors. Depending on the lender, mortgage rates can also vary greatly in their terms.

    In this guide, we go over essential information about mortgage rates, including tips on how to get better rates on your mortgage.

    Defining Mortgage Rate

    The mortgage rate is the rate of interest charged on your mortgage, as determined by the lender. It can either be fixed and stay the same for the life of the loan or be variable and fluctuate with the benchmark interest rate. This rate also varies according to the borrower’s credit profile. Like the homebuyers' market, mortgage rate averages also move along with interest rate cycles.

    For homebuyers looking to purchase a new home, the mortgage rate is one of the most important things to consider. Other factors also include collateral, principal, taxes, interest, and insurance. 

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    Interest Rate and APR: What’s The Difference?

    When taking out a mortgage, you’ll be presented with an interest rate as well as an APR. While these may look similar, there are several key differences

    Usually presented as a percentage, interest rate is the cost of borrowing the principal – your initial loan amount. This is also called the “interest expense”. For example, if your mortgage loan is valued at $300,000 with a 6% interest rate, your annual interest expense would be $18,000. This means you’ll be paying $1,500 monthly on your interest.

    Also presented as a percentage, APR (annual percentage rate) includes interest expense on your loan, but it also includes all other related fees. An APR also puts into consideration broker fees, closing costs, and rebates. Generally, the APR should be higher or equal to the interest rate. When shopping around for a mortgage, the APR is the more effective rate to consider since they include costs not covered in the interest rates.

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    How Is A Mortgage Rate Set?

    Generally, lenders adjust your mortgage rates depending on the risk of the loan. If a loan is riskier, it will have a higher rate. The likelihood of you falling behind on your payments and the money they stand to lose if you default on your loan are key factors when it comes to adjusting the mortgage rate. 

    To estimate your ability to make your payments on time, lenders look at your credit score. Generally, those with credit scores of 740 or above will get the most expensive choice of loan products and the lowest interest. 

    The lower your score, the fewer choices available to you. You will also likely be charged more on interest. If you have a very low credit score (below 620), most of the loan options available to you are guaranteed by the government – not private insurers.

    Lenders use the loan-to-value (LTV) ratio in order to calculate how much money they stand to lose if you can’t pay off your loan. This ratio measures the amount of your mortgage compared to the home’s value. For example, if you're buying a $160,000 house with a $32,000 down, you’d have to take out a $128,000 mortgage. Your LTV would be 80% (128,000/160,000 = 80%). An LTV above 80% is considered high and will incur higher interest rates, as well as require mortgage insurance.

    There are also factors playing a part in mortgage rates that are beyond the borrower’s and lender’s control. These factors usually are tied to the economy. When the economy is strong, mortgage rates tend to rise. Conversely, when the economy is slowing down, mortgage rates tend to fall. 

    Another influence on mortgage rates is the inflation rate. As the dollar loses buying power from inflation, prices go up, and lenders will demand higher rates to compensate. For most of the past decade, the 30-year fixed mortgage rate has lingered below 5% because of low inflation. 

    An improving economy is usually signaled by job growth, higher wages, and higher interest rates. However, despite a steady increase in the number of jobs since October 2010, economic growth has been inconsistent, and mortgage rates are still falling. 

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    Different Types of Mortgages

    The type of mortgage that you get directly impacts your rates. Here's a breakdown of the most common mortgages and how much they cost you.

    Conventional Fixed-Rate Mortgages

    Conventional mortgages are loans that are not insured by the government. Conventional mortgages are divided into two categories: conforming and non-conforming. 

    A conforming loan means that the loan amount is under the limits set by the Federal National Mortgage Association (a.k.a. FNMA or Fannie Mae) or the Federal Home Loan Mortgage Corporation (a.k.a. FHLMC or Freddie Mac), the organizations backing US mortgages. Typically, lenders will require you to pay private mortgage insurance on these loans if you put a down payment of less than 20% of the home's value. 

    Conventional mortgages are generally more flexible since you can use them for your primary residence, second home, or investment property. Borrowing costs are lower than other mortgages, although interest rates may be slightly higher. Another advantage is that you can ask your lender to cancel private mortgage insurance once you have 20% equity. Since the loans are backed by the government, you can pay as little as 3% on your down.

    Conventional mortgages are fixed-rate, which means they keep the same rates over the life of the loan. This means your monthly mortgage payments will always stay the same. This type of mortgage usually comes in terms of 15 years, 20 years, or 30 years. 

    In a conventional loan, the mortgage rate varies depending on the term of your loan. As of August 2020, the current average rate for a 30-year fixed-rate mortgage is 3.13%, 3.03% for a 20-year loan, and 2.59% for a 15-year loan.

    This kind of mortgage also usually requires you to pay more interest on longer-term loans. Another thing to keep in mind is that on longer-term loans it’ll take longer to build equity in your home. 

    One thing to note if you’re taking out a conventional mortgage is that you must have a minimum FICO credit score of 620. You will also need to prepare documents to verify your income, assets, down payment, and employment.

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    Jumbo Mortgages

    Jumbo mortgages are a type of non-conforming loan, which means that the amount loaned exceeds federal loan limits. In 2020, the maximum conforming loan limits for single-family homes range from $510,400-$765,600.

    A jumbo loan allows you to borrow more than this, usually when you’re looking to buy a more expensive luxury home. Compared to other conventional loans, the rates tend to be more competitive as well. As of August 2020, the average rate on a jumbo loan stands at 3.125% for a 30-year loan and 2.875% for a 15-year loan.

    However, you must put a down of at least 10 to 20 percent on your mortgage. The credit score requirement is also higher since you’ll need at least a 700. However, some lenders may consider a minimum score of 660 in some cases. Another thing to note is that you must have proof that you have significant assets – at least 10% of the loan amount in cash or a savings account.

    Government-Insured Mortgages

    These loans are backed by one of three government agencies: the Federal Housing Administration (FHA), the US Department of Agriculture (USDA), and the US Department of Veterans Affairs (VA). Each has its own set of eligibility criteria.

    FHA loans are designed to help homeowners who don’t meet the minimum criteria for a down payment and/or credit score. A minimum of 580 FICO score is needed to qualify for an FHA loan, compared to 629 for a conventional loan.

    These loans also require you to pay for two mortgage insurances. One is paid upfront, and – if you pay less than 10% on down – the other is paid yearly until your loan is paid off.

    USDA loans are aimed at moderate- to low-income borrowers. These homes must be located in USDA-eligible areas, and borrowers must meet certain income limits to qualify. Some of these loans do not require any down payment if you are a low-income borrower.

    VA loans provide low-interest mortgages for members of the military – active and veteran – as well as their families. Generally, these loans do not require a down payment or PMI, and closing costs are capped. However, you have to pay a funding fee to help offset the program’s cost to taxpayers. This fee is usually rolled into the monthly loan payment or paid upfront at closing.

    These government-insured loans have more relaxed credit requirements and may help if you don’t qualify for conventional loans. The smaller down payment requirement also makes it more attractive to potential borrowers. These loans offer more competitive interest rates compared to a conventional mortgage. The VA loan features a 2.75% average rate for a 30-year loan. FHA loans are similarly competitive, offering a 2.92% average rate for a 30-year loan.

    However, there are several drawbacks as well. The mandatory mortgage insurance cannot be canceled, and you’ll have to pay more in overall borrowing costs. To prove your eligibility, you’ll also need extensive documentation.

    Adjustable-Rate Mortgages

    Adjustable-rate mortgages (ARMs) have fluctuating rates that move along with market conditions. Some ARM products feature a fixed interest rate for a few years before the interest rate becomes variable for the rest of the loan’s life. This will allow you to enjoy lower interest in the first few years of the loan, saving you money on interest payments. 

    One of the most common forms of ARM is the 5/1 ARM. This is a mortgage loan that has a fixed interest rate for the first five years and then switches to an adjustable-rate mortgage for the rest of its life. After the initial five-year period, the mortgage rate can be adjusted up or down annually. As of August 2020, the average interest rate for a 5 1 ARM is around 3.33%. 

    We’d recommend that you find a loan with an interest rate cap so that you don’t end up paying excessive interest. You must also pay attention to property values because if it falls, you’ll have a harder time refinancing or selling your home.

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    Comparing 15-Year And 30-Year Mortgages

    15-Year Mortgages

    This kind of mortgage gives you 15 years to pay off your entire mortgage. While the higher monthly payment may discourage some people from taking this option, a shorter mortgage does have its own benefits. 

    By paying off your loan quicker, you can build equity faster and take the quicker path to full ownership of your home. Because lenders are exposed to fewer years of risk, they usually give out lower average rates. You also only pay for half the years of interest compared to a 30-year fixed mortgage.

    However, these loans have bigger monthly payments. Generally, they’re about 50% higher compared to a 30-year home loan. Spending more on your mortgage means that you have less money available for investments and savings. The higher monthly payment would also mean that you’ll likely only qualify for a smaller loan, limiting your choice of homes. 

    If you can afford the higher payments while putting away enough money for your savings, a 15-year fixed mortgage could be right for you. However, if your income is unstable, it might be advisable to avoid the 15-year loan. If the payments become too much, you’ll be stretching your finances too far, and you stand a chance of losing your home.

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    30-Year Mortgages

    A 30-year mortgage is the most common option for a fixed-rate loan. By paying off the loan in 30 years, you save more on monthly payments. Lower monthly payments can provide you with more peace of mind, knowing that you’ll still be able to pay for your house despite running into some financial issues. 

    The money you save from paying lower monthly payments can also go into your savings or investments. And if you still have some money left over, you can make a voluntary mortgage payment to help pay your loan off sooner.

    A major drawback of having a long-term mortgage is that the interest adds up. You’ll end up paying much more in interest expenses on a 30-year fixed term. However, this can be offset by selling your property or refinancing before the loan term expires. 

    If you’d rather build up savings and are looking for long-term stability, a 30-year mortgage might be preferable for you. 

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    What’s The Average Interest Rate On A Mortgage?

    Average mortgage rates vary depending on the type of mortgage you take out. Generally, a shorter-term mortgage would net you a better average rate because you make fewer payments. However, a 15-year mortgage would require a higher monthly payment since you’re trying to pay off the entire loan in half the time of a 30-year loan. 

    As of August 2020, the average interest rate of 30-year fixed-rate mortgages stands at 3.13%, while 15-year fixed-rate mortgages average at 2.59%. 30-year jumbo rates are holding at 3.125%, and 15-year jumbo rates are at 2.875%. 5/1 ARM rates average at 3.33%.

    From the data, 30-year fixed rates are higher than 15-year fixed rates. Compared to a 15-year loan, you’ll pay less monthly with a 30-year fixed-rate mortgage but you’ll pay more in interest during the life of the loan. 

    What Kind Of Mortgage Is Right For You?

    With the different types of mortgages having varying terms, it’s important to make sure that the mortgage you choose fits your financial situation. Ideally, you should know what your priorities are regarding mortgages, whether you’re pursuing financial stability or you’re looking to pay off the mortgage as soon as possible.

    If you have strong credit and a stable income, a conventional fixed-rate mortgage could be right for you. This way, you can take advantage of the 3% down payment and a lower borrowing cost. This works best if you plan to stay in your home for at least seven to ten years. You can also take advantage of the stability of your monthly payments to budget other expenses better.

    A jumbo loan is appropriate if you’re looking to buy a high-end home in an expensive area. Compared to taking other loans of a similar value, a jumbo loan would net you better rates on mortgages. 

    If you fit the requirements, government-insured mortgages can be a very cost-effective way to own a home. In the case of VA loans, they generally have the best terms and are the most flexible compared to other loans, as long as you’re an eligible military borrower. If not, there are FHA and USDA loans as well.

    An adjustable-rate mortgage is preferable if you’re comfortable in taking some risk on your loan. If you don’t plan to stay in your home beyond a few years, an ARM would get you great savings on interest payments. Having a 5/1 ARM also grants you a chance to get a lower interest when it readjusts after every year. 

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    How To Get A Better Average Rate On Mortgage

    • Figure out how much you can afford. The amount of the loan will directly impact the rates a lender will give you. 
    • Improve your FICO credit score. Better credit scores convince lenders that you’re able to repay on time. This will increase the likelihood of better rates for mortgages.
    • A record of employment will make you more attractive to lenders. Being steadily employed for two years (with the documents to prove it) will make a good case for better mortgage rates.
    • If you’re self-employed, document your business income and tax returns. Lenders are stricter on self-employed borrowers, so make sure you have documentation of your income and tax returns for the past two years. Lenders will also ask you to execute IRS Form 4506 that will allow them to obtain a transcript of your returns to verify your documentation. 
    • Putting more money on your down payment can help you get a better rate on your mortgage. You’ll also save by not having to pay for private mortgage insurance. 
    • If a traditional 30-year fixed-rate mortgage doesn’t make financial sense for you, consider an adjustable-rate mortgage. It might save you money if you plan to sell your current house and buy another one in the near future.
    • Consider a shorter mortgage. If you have good cash flow and are looking to stay long-term in your current home, consider a shorter mortgage so you can pay it off sooner. While this means you need to pay more monthly, it also means that you’ll save a lot of money on interest expenses.
    • Shop around for mortgages. When looking for a good rate on your mortgage, have options. Ask around and compare the rates they give out so that you can pick the one whose terms suit your needs.
    • Remember to lock in your rate. Since closing a loan may take weeks or months, your interest rate might fluctuate during that period. Rather than having to accept a possibly worse rate, ask your lender to lock in your rate. It does come with a fee, but it’s better than getting stuck with a higher rate.
    • If you’re confident enough in your credit score (800+), ask your lender to lower the rate.
    • Set up automatic mortgage payments. This will ensure that you always pay your current mortgage on time and could convince your bank to give you lower interest rates.
    • Consider paying for discount points. Discount points can get you a reduction in your interest rates. One thing to keep in mind with discount points is that you usually pay thousands of dollars upfront to save a few dollars monthly. It’ll take years for your spending to break even. If you don’t plan on having the mortgage for a long time, you can safely skip discount points.
    • Consider refinancing your mortgage. Refinancing your current mortgage may get you a lower monthly rate.
    • Look around for state-run first-time homebuyer programs. Do some research to see if your state offers a program that will offer you down payment grants with more favorable interest rates.
    • Have cash in reserve. Generally, lenders like it better if you have two months’ worth of liquid cash reserves to pay for your mortgage. This reserve includes money saved in checking or savings accounts, money market funds, or certificates of deposit. On higher-risk mortgages, they might ask for more cash in reserve as security.
    • When shopping for a house, consider other expenses. Aside from mortgage payments, take into account other expenses related to homeownership like taxes, insurance, and maintenance.
    • Wait before applying for new credit. If you open a new credit card or take another loan close to your mortgage application, it might cause your credit score to dip. This, in turn, would negatively impact your interest rate.
    • Hold off on big purchases. Lenders make a final credit check before closing the loan, and any new debts incurred would impact your eligibility. 
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    Conclusion

    With all of the options available, choosing the right mortgage is a challenge. Interest rate is a huge factor in determining which loan you go with – the lower your rates, the less you have to pay every month.

    There are many things you can do to get more favorable rates, like improving your credit score and choosing the right type of loan for your financial goals. Just keep in mind that while it's very important, interest is just one aspect you should consider when signing up with a lender.

    If you want to save on mortgage interest, Wesley Mortgage, LLC should be your first choice for consultation. Our team will advise you on your loan options while finding the best rates for you. Contact us today for more information.

    Written By Ed Wallace
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