What Is a Mortgage Interest Rate?
Definition and Example of a Mortgage Interest Rate
A mortgage interest rate a percentage of your total loan balance. It's paid on a monthly basis, along with your principal payment, until your loan is paid off. It's a component in determining the annual cost to borrow money from a lender to purchase a home or other property.
Investors require higher interest rates to make back money when the economy, stock market, and foreign markets are strong. This causes lenders to raise their rates. Bond investment activity can also impact mortgage rates, as well as your personal financial situation. Nonetheless, you might have some options to reduce your lender's quoted interest rate when you're looking to buy a home.
What Is a Mortgage Interest Rate?
Your mortgage interest rate is what it costs you each month to finance your property. It's an extra amount you must pay to your lender in addition to paying off the amount that you've borrowed. Your interest rate is effectively the lender's compensation for letting you use its money to purchase your property.
How Does a Mortgage Interest Rate Work?
Mortgage interest rates can vacillate depending on larger economic factors and investment activity. The secondary market plays a role. Fannie Mae and Freddie Mac bundle mortgage loans and sell them to investors looking to make a profit. Whatever interest rate those investors are willing to pay for mortgage-backed securities determines what rates lenders can set on their loans.
The stock market falters.
There are dips or insecurities in foreign markets.
Unemployment increases or jobs decrease.
The stock market is strong.
Foreign markets are strong and stable.
Inflation is up.
Unemployment is low and jobs are increasing.
This chart illustrates how 30-year fixed-rate mortgage rates changed from 2000 through 2019.
But these are specifically rates, simply a cited and agreed-upon percentage. The amount of interest you pay each month will decrease as you pay off the principal balance you borrowed and as that number also decreases. Your percentage interest rate applies to that remaining balance.
You'll pay 5% of your total loan balance in interest if you have a 5% mortgage rate and you're making your first mortgage payment. Your principal balance should be much less 10 years later, and you would only pay 5% of that balance at that time.
Mortgage Interest Rate vs. Annual Percentage Rate (APR)
|Mortgage Interest Rate||Annual Percentage Rate (APR)|
|Is a percentage of the amount of money you borrowed||Is based on your interest rate, points, broker fees, and other costs.|
|Can be found under "Loan Terms" on your loan estimate||Can be found under "Comparisons" on your loan estimate|
|Is typically lower than your annual percentage rate because it's just one component of your APR||Is usually higher than your mortgage interest rate|
Your annual percentage rate is more of a complete picture of how much it costs you to borrow.
Effect of Mortgage Interest Rates on the Market
Mortgage rates don’t directly impact home prices, but they do influence housing supply—which plays a big role in pricing. As mortgage rates rise, existing homeowners are less likely to list their properties and enter the market. This creates a dearth of for-sale properties, driving demand up and prices with them.
When rates are low, homeowners are more comfortable selling their properties. This sends inventory up and turns the market in the buyer’s favor, meaning more options and more negotiating power.
It depends on how much rates rise, however. It can stifle demand if rates rise for too long or get too high—even for the few properties that are out there. That would force sellers to lower their prices in order to stand out.
How to Get a Good Mortgage Interest Rate
Rates vary by lender, so it’s always important to shop around for the mortgage lender that's offering the best terms. Each lender has its own overhead and operating costs and has to charge differently in order to make a profit.
In addition to market and economic factors, the rate you’re offered depends largely on your own financial situation. A lender will consider:
- Your credit score
- Your repayment history and any collections, bankruptcies, or other financial events
- Your income and employment history
- Your level of existing debt
- Your cash reserves and assets
- The size of your down payment
- Property location
- Loan type, term, and amount
The riskier you are as a borrower and the more money you borrow, the higher your rate will be.
You can apply for a mortgage to several lenders at once, or you can go to a mortgage broker who will do the shopping for you to make sure you're getting the best rate. Brokers can often find lower rates thanks to their industry connections and access to wholesale pricing.
Regardless of which route you choose, make sure you’re comparing the full loan estimate—closing costs included—to accurately see whose pricing is more affordable.
Do I Need to Pay a High Mortgage Interest Rate?
You can usually pay discount points to lower the rate you're offered. These points are essentially a form of prepaid interest. One point equals 1% of the total loan balance, and it lowers your interest rate for the life of your mortgage. The amount it lowers your rate depends on your individual lender and the current market.
This is often called “buying down your rate.” Calculate your break-even point—the time it will take for you to recoup the costs of the points you purchased—to determine if this is the right move for you. Will you be in the home long enough to make it worthwhile? The longer you plan to live there, the more paying discount points makes sense.
- A mortgage interest rate is the percentage of your existing principal loan balance you pay your lender in exchange for borrowing the money to purchase a property.
- It’s not the same as your annual percentage rate (APR) which takes other costs, including your mortgage interest rate, into consideration.
- You’ll typically pay a higher mortgage interest rate if your credit is poor or if you have other negative financial issues.
- You can lower your mortgage interest rate by buying “discount points,” but this means more money upfront and might not make sense if you’re not planning to stay in the home for a while.
Accessed July 8, 2020.
Urban Institute. "The Impact of Higher Interest Rates on the Mortgage Market." Page 6. Accessed July 8, 2020.
CFPB. "Seven Factors That Determine Your Mortgage Interest Rate." Accessed July 8, 2020.
CFPB. "What Are (Discount) Points and Lender Credits and How Do They Work?" Accessed July 8, 2020.