- August 30, 2017
- Posted by: steve
- Category: mortgage rates
Does the Mortgage Company Have Any Reason to Steer Us Toward a Higher Mortgage Rate?
Is there actually a benefit to paying a higher mortgage rate? Here’s why your mortgage company might have a good reason for steering you towards one.
Purchasing a home is an important milestone.
Homeowners experience the pride of ownership, as well as the freedom to make their own choices about their living space.
Building equity is also a great benefit of owning a home. In fact, research shows that homeownership is still one of the most effective ways to build wealth.
That said, while buying a home can be a smart financial investment, it’s crucial to get a good deal. This means considering not only the price of the home you’re purchasing, but also the terms that you negotiate with your mortgage company.
It’s important to go into the conversation with your mortgage company knowing what your options are. So, to get the best rates possible, you should start with some research.
Let’s take a look at what you need to know to get the best deal on your mortgage.
Types of Mortgages
Before we discuss the types of rates available a mortgage, it’s important to understand the different types of mortgages available. The type of mortgage you choose will impact the rates you get.
Conventional loans are private loans. These loans are not insured by the federal government. For this reason, a mortgage company will typically require a down payment of at least 5% and a credit score of at least 620.
Also, since these loans are not guaranteed by the government, they tend to come with a higher interest rate.
Federal Housing Authority (FHA) loans are backed by the United States department of Housing and Urban Development (HUD). Since these loans are insured by the federal government, they only require a 3.5% down payment.
Loans from the Veteran’s Association are available to qualified members of the armed services. These loans are a great benefit, as they don’t require any money down.
If you’re a service member, you can use this calculator to get prequalified for a loan!
A United States Department of Agriculture (USDA) loan is another option that doesn’t require any money down. These loans are only available in certain rural areas. Also, borrowers cannot exceed certain income limits.
Understanding Your Mortgage Payment
The type of mortgage you choose is only one factor in determining what your monthly payment will be. Identifying the aspects of your mortgage payment will help you understand your interest rate.
When you talk to your mortgage company about your monthly payment, you might hear them refer to the acronym PITI. This stands for Principle, Insurance, Taxes, and Interest. Together, these four factors add up to your monthly payment.
The principle is the amount that goes towards paying down your mortgage. This will be determined by the cost of your home, the amount of money you put down, and the length of your mortgage.
So, for example, if you choose a 15-year mortgage instead of a 30-year mortgage, you’ll have a lower principle payment each month.
By contrast, the smaller percentage you put down for a down payment, the higher the principle payment will be.
There are two kinds of insurance to consider when buying a home: homeowner’s insurance and mortgage insurance.
Homeowner’s insurance covers the cost of potential damages to your home. Your mortgage company will require that you work with an insurance company in order to get a mortgage.
By contrast, mortgage insurance covers the liability of foreclosure. All conventional and FHA loans with less than a 20% down payment will require mortgage insurance.
All homeowners must pay property taxes on their property. The cost of your taxes will depend on your home’s value, size, and location. Also, you’ll typically pay higher taxes if you are using your home as a rental property.
Finally, the fourth item in your monthly payment is the interest on your loan.
Buyers have the choice between a loan with an adjustable rate and a fixed rate. Adjustable rate loans will fluctuate with market conditions, while fixed rate loans will lock in today’s rates.
Adjustable loans typically have the advantage of lower rates early on in the loan. Also, if interest rates fall later, you won’t have to refinance to take advantage of them. At the same time, if rates increase, you’ll see your monthly payments go up.
By contrast, a fixed rate loan provides stability. Your monthly payment will be the same in year one of your mortgage as it will be in year 20.
Factors that Affect Your Interest Rate
It’s important to understand how the mortgage company will calculate your interest rate. In addition to considering daily rates, mortgage companies also take several factors about the borrower into consideration.
Your FICO credit score is a number that reflects your history of paying off loans on time. Your mortgage company will look to this score to determine how likely you are to make your mortgage payment.
Before you start looking at mortgages, get a copy of your credit report. If your score is below 580-600, you should consider taking some time to repair your credit before purchasing a home. Also, if you’re purchasing a home with your spouse, make sure to look at both of your credit scores.
One of the best indicators that you will be able to pay your loan is a steady source of income. For this reason, lenders prefer borrowers who have a history of employment with the same company for at least 3 years.
Location of Your Home
The location of the home you purchase will also affect interest rates. Homes in more populated, urban areas tend to have higher interest rates than homes in rural areas.
Length of Your Loan
Borrowers typically choose between a 15 year and 30-year mortgage. A 15-year loan will have a lower interest rate, but higher monthly payments.
As a general rule, the more money you place in a down payment, the lower your interest rate will be. This is because you will be borrowing less money, which makes your loan look less risky to lenders
Why Your Mortgage Company Might Steer You Towards a Higher Interest Rate
When it comes to interest rates, most people assume that lower is always better. They may believe that the only party that benefits from a higher interest rate is the mortgage company.
To a certain extent, this can be correct. But, when weighing all the factors, there may be times when a higher rate is a better choice.
When You Can’t Afford a Higher Down Payment
One factor that will determine your interest rate is the calculated risk that you will default on your loan.
By charging higher interest, the mortgage company will still make a profit on the loan, even if the borrower defaults.
For this reason, borrowers with a larger down payment will usually get a lower interest rate. This is because the more money you put down, the less money you borrow, which puts you at a lower risk of default.
At the same time, putting more money down also leaves you with less liquid cash and flexibility. This means that if you lose your job, you won’t have emergency funds to cover expenses (or pay your mortgage).
For this reason, it might be worth it to take choose the higher interest rate and put less money down. This way, you’ll still have emergency savings. Not to mention, your interest will be tax deductible–but more on that later.
To Avoid Paying Mortgage Insurance
Most borrowers, unless they put 20% down, will have to pay mortgage insurance for at least part of the life of their loan. How long you will have to pay mortgage insurance will depend on what kind of mortgage you choose.
For instance, with an FHA loan, borrowers will need to pay mortgage insurance for the whole life of the loan. With a conventional loan, however, you will no longer have to pay mortgage insurance once you’ve paid down 80% of your principle.
That said, conventional loans typically have a higher interest rate than FHA loans. This is because they’re not guaranteed by the government. The benefit of not having the pay mortgage insurance for all 30 years, though, might be worth the higher interest rate.
Remember that Interest is Tax Deductible
One of the main reasons that choosing a higher interest rate can be a good choice? Because the interest, unlike the principle, is tax-deductible. So, putting less money down on your down payment could save you money. This is because you’ll get a bigger tax deduction.
Choosing the Right Mortgage
Many homeowners get nervous about taking on debt.
They assume that paying off their mortgage as quickly as possible, and paying as little interest as possible, is the best financial move.
In reality, waiting longer to pay off your home could give you more flexibility with your money.
Also, maintaining a balance on your mortgage will give you the ability to claim tax credits on interest for a longer period of time. Remember that paying off your mortgage faster won’t impact your ability to build equity in your home.
If you’re ready to work with a mortgage company to purchase a home, contact us. We’ll work with you to find the mortgage that is right for you.