If you’re in the process of getting a mortgage right now or just shopping around for the best possible interest rate, you may have noticed something. When you get the rate from the loan officer, it doesn’t necessarily match the rate shown on the lender’s website. What’s up with that?
To understand the answer to that question, we need to go over a little bit about how the mortgage market works and how the risk of any given loan is measured to get to your interest rate. After we touch on that, we’ll go over what you’re actually seeing when lenders advertise a set of rates on a website or elsewhere.
Understanding Mortgage Bonds
There was a time when you would walk into a bank and get a 30-year fixed-rate mortgage. The bank would hold on to that mortgage and collect the payments on your loan for as long as it took the loan to be paid off. Sometimes this is still the case, but it’s increasingly becoming more of a rarity.
Most mortgages are now sold on the bond market. We’ll briefly go over how this process works here, but you can take a deeper dive into market interactions if you choose.
When you get your loan, it’s typically pooled into a big group of loans with similar characteristics (e.g. conventional 30-year fixed loans with a 720-plus credit score and a 10% down payment) before being purchased by one of the major mortgage investors. These pools are referred to as mortgage-backed securities (MBS). You might have $10 million worth of loans in a particular MBS.
If you get a conventional loan, it was purchased by Fannie Mae or Freddie Mac. Otherwise, they get purchased by a government agency. This is the case with FHA, USDA and VA loans. These agencies also have certain requirements for the types of loans they’ll buy because they take on the foreclosure risk that helps provide investor liquidity for the next step in the process.
Once the loan has been bought by the investor, the MBS are then made available on the open market. The mortgage investor guarantees to make payments to the bond buyer each month for interest and principal.
Each bond is priced according to movements in the market and loan type (e.g. rates on VA loans tend to be a bit lower). That’s how the base rate is determined. That being said, a big part of your rate is influenced by both the particulars of your transaction and your financial situation. Let’s take a look at what goes into your personalized rate.
Understanding Your Rate
If it was all based on trades in the bond market, everyone’s rate would be very similar and it would be easy to tell you what your rate would be at any given time. Lenders, including Quicken Loans, need a little more information from you. This deals with both the type of loan you’re getting and your personal loan qualifications.
Loan Ladder Price Adjustments
When you get a mortgage, there are often adjustments made based on the characteristics of your individual loan. All mortgage types start with a base rate. Then your rate is adjusted up based on a variety of factors, including:
- The type of transaction (your rate will be slightly higher for a cash-out transaction then it would be if you were just looking to lower your rate or change your term).
- The loan amount affects your rate.
- Your credit score also has an effect. The higher your credit score, the better your rate will be in general. Your debt-to-income (DTI) ratio is also included. It’s important to note that while this is a hard credit pull that will affect your score, you can make multiple applications while shopping around and it all counts as one pull.
- The size of your down payment or the amount of equity you have in your home also makes a difference.
- Whether your property is a primary home, vacation or investment property affects your rate. Vacation homes and investment properties will have a higher rate because they do represent a higher lending risk.
What the Loan Ladder Means for You
What does all this mean for you in terms of your rate? Every factor mentioned above influences how much you pay at closing in order to qualify for a certain rate.
These fees paid to buy down your rate are called discount points. One discount point is equal to 1% of the total loan amount. You can buy discount points in increments as small as 0.125 points.
On a $200,000 loan, if you had to pay 0.5 points to get a rate of 4.125%, you would pay $1,000 in fees to secure that rate. Conversely, if you wanted to keep your closing costs as low as possible, you can take a higher rate and have the lender give you a credit toward your closing costs.
Understanding the Rates on the Website
Now that you know how lenders get to your rate, what exactly are those rates on the website? Good question.
Ideally, every lender would probably love to not have to publish public rates at all because your rate is going to be so different given your loan type and financial situation. However, people like to comparison shop for everything else and your mortgage is no different.
Somewhere on their website, every lender has a rates page. When you look at these pages, there are a couple of important things to take note of.
Interest Rate vs. APR
First, you’re going to want to look at the difference between the interest rate and the annual percentage rate (APR).
The lower rate you see on the page is the rate of interest on the mortgage. The APR considers the interest rate plus the additional closing costs and other fees over the life of the loan. The bigger the difference between the interest rate and the APR, the higher the fees the lender is charging.
Because the rate they give you on the website can’t be personalized for your situation, all lenders have to base the rates they show you on something. There are listed assumptions somewhere on the page about all sorts of items affecting the rate, including:
- Down payment size or the amount of equity you have (you may see this referred to as LTV)
- Credit score
- Loan type and purpose of the loan (buying a home, rate/term home loan, cash-out refinance)
- Loan amount
We hope this is giving you a little bit of insight into how to shop for interest rates. If you’re getting ready to buy a new house or refinance your current one, we would want to help you get started online. Otherwise, you can give one of our friendly Home Loan Experts a call at (800) 785-4788. They’ll be happy to answer any other questions in the comments below.
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