Wondering why mortgage interest rate differs? Like traditional banks, mortgage banks and other institutions charge interests that are payable over the mortgage term. This is because you are using the lender’s money to finance your home purchase. The mortgage interest rate is the lender’s reward for borrowing you the principal.
Interest is charged on all mortgages and is expected to be paid by the borrower no matter how long it takes to pay up the principal. While all mortgages attract interest, they differ from one loan to another.
Two broad interest types exist on mortgages. They are ‘fixed’ and ‘adjustable’ interests. Mortgages with fixed interests are referred to as ‘fixed-rate mortgages’ while those with adjustable interests are ‘flexible rates’ mortgages. While these two are the commonest, sub-varieties exist under each broad type.
Fixed Mortgage Interests
In fixed-rate mortgages, the interest payable on the principal is fixed from the beginning to the end of the term. From the beginning of the payment, borrowers pay the same amount as interest until the principal is paid in full. Fixed interests are uncomplicated compared to adjustable mortgages. This simplicity, sometimes, motivates lenders to choose it rather than the latter.
One of the advantages of fixed mortgages is that there is no fluctuation no matter what the market dictates. For example, a fixed interest of 10% on a 20 years mortgage of $200,000 will lead to a monthly payment of approximately $1,930 (fees and taxes included). This payment will remain constant all through the 20 years period of the loan.
On the other hand, fixed mortgage interest rates prevent borrowers from taking advantage of slumps in market rates. No matter the market trends, interest remains constant.
Adjustable Mortgage Interests
Unlike fixed interests, adjustable interests change over time as the loan period elapses. In an adjustable mortgage, a fixed interest is paid for a set period, after which the interest rate changes based on an agreed index and continues every year or month.
After the fixed period has elapsed, the interest payable is readjusted for every subsequent payment based on the remaining principal. As a result, while the amount repaid monthly may remain the same, interest repaid reduces, and principal adds up to the balance. For example, a borrower who pays $510 on an adjustable mortgage will pay the same until the end of the term. But as the loan matures, the principal reduces, and so does the actual interest repaid. An amortization schedule is used to calculate how much a borrower is expected to pay back every month till the full loan is paid.
Why Mortgage Interest Rates Differ
· Loan term
The availability of mortgage terms of 15, 20, or 30 years provides various options for lenders to choose from. This choice has consequences on the interest rate. Generally, long-term mortgages like 20 or 30 years have higher interest rates compared to terms of 15 years or lower. Because the risks associated with long-term loans are higher, their interests tend to follow suit.
· Mortgage Interest rate
As shown above, rates are determined by the specific form of mortgage interest rate. The interests repaid on a fixed mortgage remain the same throughout the loan period. On the other hand, the interest is repaid on an adjustable mortgage change, even as the total monthly payment remains the same.
· Change in Market rates
The market always determines mortgage interests which are known as the market rate. The securities-backed bond market influences the existing mortgage rates in the market. Other important factors that affect market rates are inflation and deflation. In the end, a borrower will pay more or less depending on the existing market rates on their specific loan type. For adjustable mortgages, this change in market rates affects their interests after every readjustment.
· Borrowers credit profile
Before approving a mortgage, the lender assesses the borrower’s credit profile to determine their creditworthiness. The question is simple, ‘will this borrower default?’. Depending on the answer, a lender may charge a higher or lower interest. This is in a bid to account for the risk taken. Know more about how to build credit.
Interests primarily benefit the mortgage institutions, but their varieties can offer lenders different options to choose from. So, when searching for a housing loan, a borrower should consider factors like their intended repayment period, loan size, location, etc. All these factors will affect the mortgage interest rate to be paid on the loan.