Different Parts of a home loan interest rate

Behind the scenes, there are many elements that go into properly pricing an interest rate. The interest rate takes in to account the loan amount, your credit score, lock period, lender paid origination charges, lender credits, and any promotions that the lender is currently offering.

How does the loan amount and credit score impacts a home loan interest rate?

The loan amount and credit score typically get lumped together as risk and a negative or positive adjustment is applied to the rate. So for example, if you are qualified for a $4,000,000 loan (WOW! wouldn’t that be crazy?) but your credit score is on the lower end, the lender may apply a positive adjustment to the rate based on the risk. Conversely, if you are applying for a $200,000 loan with a credit score on the higher side, the lender would apply a negative adjustment to the rate based on the lower risk.

How does lock period influence a home loan interest rate?

When a loan originator quotes you an interest rate, it is based on the market at the time that they are quoting you the rate. That rate can rise or fall during the process of document collection and underwriting. To stabilize the rate and give real numbers to the lender and the borrower (you), the originator will lock the rate for a period that they estimate will get the borrower to closing. The longer the period of the lock, the higher the adjustment to the interest rate. For example, a 30-day lock may cost -0.17 and a 60-day lock may cost 0.13. That is a difference of .3% on a rate. While it may seem like you should just lock the loan for the least amount of time, there are penalties when you extend past the lock period without closing the loan, so it is advantageous to capture all of the time that is projected to get the loan to closing within the lock period.

It is also possible to float the rate while you do some of the processing of the loan. Floating the rate means that the rate will fluctuate with the market, and the borrower is not tied to any rate. It is not possible to close the loan, or even fully disclose the loan, until the loan is locked. However if the market took a downturn, and you expect it to recover within a week or two, you can lock the rate later. This does a couple of things for the borrower. First, it lessens the lock period substantially, ultimately lowering the interest rate. It also gives the opportunity to lock at a lower rate if the market shifts in favor of the borrower. The risk to this method is that if the market shifts adversely to the borrower, they will receive a higher interest rate.

What are origination charges and how do they affect a home loan interest rate?

Origination charges are the costs involved with originating the loan. This is paid to brokers, originators, or to the lender to cover fees associated with paying employees, advertising, and other business-related overhead. While a lot of this is built into the rate, it does influence the rate to some degree.

What are lender credits and how do they affect a home loan interest rate?

Lender credits are generally offered as a promotion (or sale) that the lender is having. For example, in order to entice  borrowers to refinance, they may have a promotion to give a half point (-0.5) credit towards the rate on all refinance loans for a specific period. This means that any loan locked within their promotion period, will have this credit applied and the savings will be returned to the borrower in terms of a lower percentage rate. This is out of the control of the borrower as there is no indication of when a lender will release a promotional credit.

Lender credits can also be granted as cash back, to cover closing costs, by accepting a higher interest rate. This is out of the scope of this article, but will be covered in the future.

Will a lender or a broker be able to offer a better home loan interest rate?

This seems to be a widely-asked question. The answer varies, however brokers are given wholesale prices for rates that borrowers do not have access to. Furthermore, brokers have access to multiple lenders, within their network, to shop rates for a particular home loan scenario to find the best interest rate. While a lender may have a better rate within their niche market, brokers will come very close and are not hindered by a restrictive overlay by a lender on certain programs. For example, Lender A may have great VA rates, however higher conventional rates. Lender B may have great rates for conventional but lacking for FHA. Lender C may have great FHA rates but the rates for Conventional and VA are higher. A broker that has broker agreements with all three lenders can take advantage of the benefits from all three lenders. To put this into an analogy that everyone can understand, think of buying an airline ticket. If you go to the website of Delta, American Airlines, or United, you may find their rate for the time and date that you are trying to fly. Or you could simply use Travelocity or Expedia that will offer rates of all of the airlines in one centralized location, and are often better than the rates that you were able to find directly. This is how mortgage brokers work.

To recap on home loan interest rates…

Many wonder how to get the lowest home loan interest rate when they are looking to purchase or refinance their home. There are many factors that go into the home loan interest rate such as the loan amount, your credit score, the lock period, lender paid origination charges, lender credits, and promotions that are going on at the time of your purchase or refinance. Loan amount and credit score are factored together to form the risk of the loan to the lender, and that risk is carried over into an adjustment to the rate. Some origination charges can either be assumed by the lender or can be paid at closing. If the lender assumes the origination charges, there is typically an increase in your home loan interest rate. Finally, choosing between originating your loan directly with a lender or using a mortgage broker can influence your home loan interest rate. While brokers have several lenders to leverage for a particular home loan scenario, lenders are tied to their own rates, overlays, and underwriting policies.

What can you do to make sure that you get the best home loan interest rate?

  1. Keep your credit score as high as you can for your situation to ultimately lower the risk of your home loan
  2. Generally speaking, you should use a mortgage broker so that you can shop multiple lenders for the best rate.
  3. If the market shifts poorly, talk with your mortgage loan originator to float the rate to see if the market bounces back before you lock

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