A mortgage rate is the percentage of interest charged for your home loan. It has a direct impact on your monthly mortgage payment. The higher the interest rate, the more money you’ll pay each month.
For example, say you want to buy a $420,000 home—that was the median home price in March 2024. With an interest rate of 7% and a 20% down payment, your monthly payment will be $2,722. With an interest rate of 3%, which was approximately the rate for much of 2021, your monthly payment would go down by nearly $1,000 to just $1,774.
Your credit score, income, debt, and other financial factors will affect your mortgage rate. The riskier it seems to a lender to loan you money, the higher the rate they’ll charge to protect their investment. Inversely, the more reliable you appear based on your credit history, etc., the less risky it seems to loan you money, and the lower your interest rate will be.
Adjustable versus fixed rate mortgage
An adjustable rate, also called a variable rate, means that your interest rate is fixed for a certain amount of time, but after that it could change. It’s a risky option because if interest rates increase after your designated amount of time, your monthly mortgage payment will increase.
Most home buyers choose a 30-year fixed mortgage, meaning the monthly payment remains the same for the life of your loan. But an adjustable rate mortgage can be a good option if you plan to sell the home in less than 10 years. You could lock in a low rate for the first several years of the loan and save thousands on your mortgage.
What determines mortgage interest rates?
The interest rate on your mortgage is largely determined by the Federal Reserve overnight funds rate. The Federal Reserve meets eight times per year to set this rate, and it’s the amount commercial banks charge their customers with the best credit.
Add three to that number and you have what’s known as the prime rate, which is a good indicator of the baseline mortgage rate you could get for your loan at any given time, depending on your credit history, income, and other financial factors.
While mortgage rates to a certain extent are outside of your control, there are many things you can do to get the lowest rate possible at any given time. Improve and protect your credit, decrease your debt, save up as much as possible for your down payment, and do everything you can to prepare financially for buying your home.
The more prepared you are and the better shape you’re in financially, the better chance you have at getting a lower interest rate. It’s always important to take control of your financial situation, but when interest rates are high, it can make all the difference in whether you can afford to buy a home or need to wait a few more years.
Sources: Investopedia, Mortgage Calculator
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