How are Mortgage Rates Determined by Lenders?

© 2009, Brandon Cornett. All rights reserved.

Reader Question: “How does a lender decide what mortgage rate I’m going to get? How are these rates determined when I apply for a loan?”

The amount of interest applied to a home loan is determined by many different factors. But all of these factors fall into one of two categories — economic and personal. Here is the difference:

• Economic factors include the rate given to banks, when they borrow money from each other. It gets complicated, so I will spare you the details. Here’s the main thing a home buyer should know about these economic factors: When you approach a mortgage lender for a loan, they will already have a certain range of interest rates they are willing to offer. This range is determined by various economic trends.
• Personal factors include your credit score, your income, the amount of money you have to put down, your current level of debt, etc. We talked about the range of interest rates a lender has. Well, when you apply for a mortgage loan, they will determine where you fall in that range based on the personal factors I’ve just mentioned.

This is how mortgage rates are determined by lenders. Economic factors will influence the rates they offer before you even approach them. Personal factors will influence the actual rate they are willing to give you, as an individual.

Researching Mortgage Rates When Buying a Home

When you decide you want to buy a home, one of the first things you need to do is determine a monthly budget / spending limit. You need to do this before you start talking to lenders, and this video lesson explains why. Once you’ve established a budget for yourself, you can start shopping around for mortgage rates with different lenders. You can do this by getting pre-approved for a mortgage loan, which is what I recommend.

At this stage, you should start researching mortgage rates to see what’s out there. You can check the average interest rates on different types of home loans with Freddie Mac’s weekly survey. Keep in mind that these are the average rates being offered by lenders in the U.S. You might qualify for a lower or higher rate than the one in the survey, and this will depend on the personal factors we talked about earlier.

Getting the Best Rates on Your Loan

Now that you know how mortgage rates are determined, let’s talk about what it takes to get the best rate on a home loan. Every lender has its own standards for qualifying borrowers. But when you look at lending practices in general, certain patterns begin to emerge. In order to get the best rates on a mortgage loan in the current economy, borrowers will probably need the following…

• A credit score (FICO) of 760 or higher
• A debt-to-income ratio below 30%
• A down payment of at least 20%

If you have these things going for you, there’s a good chance you’ll get the best rate the lender has to offer. This could save you hundreds of dollars per month on your mortgage payments. And that, my friends, is what it’s so important to maintain a good credit score.

I hope this answers your question about how mortgage are determined by lenders. If you have any other questions about the home buying process, try searching this blog through the search box up top. You might also want to read our feature article on home buying steps for first-time buyers.