What Factors Effect Interest Rate?
1. Credit Scores
Your credit score is one factor that can affect your interest rate. In general, consumers with higher credit scores receive lower interest rates than consumers with lower credit scores. Lenders use your credit scores to predict how reliable you’ll be in paying your loan. Credit scores are calculated based on the information in your credit report, which shows information about your credit history, including your loans, credit cards, and payment history.
2. Home Location
Many lenders offer slightly different interest rates depending on what state you live in. Your rate will depend on your state, and depending on your loan amount and loan type, your county as well.
Different lending institutions can offer different loan products and rates. Regardless of whether you are looking to buy in a rural or urban area, talking to multiple lenders will help you understand all of the options available to you.
3. Home Price and Loan Amount
Homebuyers can pay higher interest rates on loans that are particularly small or large. The amount you’ll need to borrow for your mortgage loan is the home price plus closing costs minus your down payment. Depending on your circumstances or mortgage loan type, your closing costs and mortgage insurance may be included in the amount of your mortgage loan, too.
If you’ve already started shopping for homes, you may have an idea of the price range of the home you hope to buy. If you’re just getting started, real estate websites can help you get a sense of typical prices in the neighborhoods you’re interested in.
4. Down Payment
In general, a larger down payment means a lower interest rate, because lenders see a lower level of risk when you have more stake in the property. So if you can comfortably put 20 percent or more down, do it—you’ll usually get a lower interest rate.
If you cannot make a down payment of 20 percent or more, lenders will usually require you to purchase mortgage insurance, sometimes known as private mortgage insurance (PMI). Mortgage insurance, which protects the lender in the event a borrower stops paying their loan, adds to the overall cost of your monthly mortgage loan payment.
As you explore potential interest rates, you may find that you could be offered a slightly lower interest rate with a down payment just under 20 percent, compared with one of 20 percent or higher. That’s because you’re paying mortgage insurance—which lowers the risk for your lender.
It’s important to keep in mind the overall cost of a mortgage. The larger the down payment, the lower the overall cost to borrow. Getting a lower interest rate can save you money over time. But even if you find you’ll get a slightly lower interest rate with a down payment less than 20 percent, your total cost to borrow will likely be greater since you’ll need to make the additional monthly mortgage insurance payments. That’s why it’s important to look at your total cost to borrow, rather than just the interest rate.
Make sure you are factoring in all of the costs of your loan when you are shopping around to avoid any costly surprises.
5. Loan Term
The term, or duration, of your loan is how long you have to repay the loan. In general, shorter term loans have lower interest rates and lower overall costs, but higher monthly payments. A lot depends on the specifics—exactly how much lower the amount you’ll pay in interest and how much higher the monthly payments could be depends on the length of the loans you’re looking at as well as the interest rate.
6. Interest Rate Type
Interest rates come in two basic types: fixed and adjustable. Fixed interest rates don’t change over time. Adjustable rates may have an initial fixed period, after which they go up or down each period based on the market.
Your initial interest rate may be lower with an adjustable-rate loan than with a fixed rate loan, but that rate might increase significantly later on.
7. Loan Type
There are several broad categories of mortgage loans, such as conventional, FHA, USDA, and VA loans. Lenders decide which products to offer, and loan types have different eligibility requirements. Rates can be significantly different depending on what loan type you choose.
Other Economic Factors that Could Affect Rates
Initial Jobless Claims
Initial jobless claims measure the number of filings for state jobless benefits. This report provides a timely, but often misleading, indicator of the direction of the economy, with increases (decreases) in claims potentially signaling slowing (accelerating) job growth. On a week-to-week basis, claims are quite volatile, and many analysts therefore track a four-week moving average to get a better sense of the underlying trend. It typically takes a sustained move of at least 30k in claims to signal a meaningful change in job growth.
Core CPI Rate
This is the CPI index excluding the volatile food and energy sectors. The market looks closely at this number because it is believed to be a better approximation of the actual rate of inflation.
Building Permits
This number is reported by the U.S. Government monthly and is usually released with housing starts. The number of permits generally provides economists with clues about the upcoming level of building starts. This is generally a good indicator of future economic activity and this number is used to calculate the Index of Leading Economic Indicators.
Personal Consumption
Also called Consumer Spending. these outlays can be segregated into three categories: durable goods expected to last three years or more (automobiles, furniture, and golf clubs); nondurable goods assumed to last less than three years (food, clothing and aspirin); and services (medical care, haircuts and legal fees). Durable goods account for approximately 14% of consumption, wheras nondurable goods account for more than 30%. Services constitute the remaining 56%.
Factory Orders
Manufacturers’ shipments, inventories, and orders. Factory orders include shipments, inventories, and new and unfilled orders. An increase in the factory order total may indicate an expansion in the economy and could be an inflationary factor.
Business Inventories and Sales
These figures measure the inventories and sales of manufacturers, wholesalers, and retail establishments. The Bureau of Census releases these figures monthly. In most cases, an increase in these numbers indicates an expanding economy that could be inflationary.
Capacity (factory) Utilization
The capacity utilization rate measures the percent of industrial output currently in use. A change in the rate indicates a change in the direction of economic activity. as the percentage rate moves closer to 90%, the industrial output is practically at full capacity and is inflationary. A number closer to 70% is recessionary. A higher percentage indicates a stronger manufacturing sector and an expanding economy that can be inflationary.
Leading Economic Indicators (LEI)
This is a composite index of ten data series designed to predict turning points in aggregate economic activity. Historically, the LEI reach peaks and troughs earlier than the turns in the economy and are widely regarding as an important tool for forecasting and planning.
Lagging Economic Indicators
Economic indicators that follow rather than precede the country’s overall pace of economic activity.
Non-Farm Payroll
Reported by the Department of Labor. An increase in employment and/or an increase in non-farm payroll suggest a healthy or expanding economy. In this scenario, there may be increased pressure on wages as demand exceeds the supply of workers. An increase in wages has widespread ramifications on the cost of goods and services, increasing inflationary pressures.
Explaining Interest Rates to Your Borrowers - PEG
Present (current market conditions)
Expectations (industry expert’s forecast)
Guidance (personal, client specific advice)
PEG is a broad economic temperature reading, a 40,000-foot overview of the market, not specifics of the market. It does not include a great deal of specific data for the previous week or upcoming week. PEG is used as a salutation, to communicate your familiarity with the markets. PEG should be short and sharp with credible information about the market that’s confident and optimistic. When the market news is not favorable, it is imperative that PEG is still delivered in a positive way. It is not to be used as a bearer of bad news.
Present:
- Answers the question, “Where are the markets today?”
- Answers the question, “What is the current economic environment”
- Should show that you are “plugged in ” and confident and should always be positive.
- Should take about 10 seconds to tell the customer
Expectations:
- Describes investor psychology and consensus beliefs about the future
- This is what reasonable/credible sources are saying about the overall direction of the economy
- Includes 1 or 2 quotes from credible sources such as an economist or other expert (name dropping)
- Should take about 15 seconds to tell the customer
Guidance:
- Helps a person place the current economic environment into context
- This section typically stays the same. You will want to check the rate range to make sure it is still accurate for the market in the event there is a major shift in interest rates
- Should take about 5 seconds to tell the customer
After you have prepared your weekly PEG, make plans to start each work day with a review of the current markets. This will keep you up-to-date on economic news and will allow you to make minor changes to your PEG (should the market drastically change) as the week progresses.
Sample PEG
Present
Stocks tumbled last week as housing and jobless-claims data, lower than expected earnings report from banks, manufacturers and industrial companies, and record-high oil prices, revived worries about an economic slowdown. As stock prices fell the bond market rallied, raising bond prices and pushing yields downward. With heightened concern over the strength of the economy, speculation has increased that the Federal Reserve will cut interest rates at the end of the month.
Expectations
Last Friday, industry experts cautioned that assessing the economy’s true state remains to be a tough challenge. however, investors have gained confidence in more rate cuts, pointing to last week’s economic events as a indication that the economy is likely. to slow and that the Fed will need to stimulate it. This week is likely to see a slight trend downward in interest rates as a result of the surge in bond prices.
Guidance
Keep in mind that interest rates change as a result of the financial markets and move upward and downward on a daily basis. Mortgage rates are still near historical lows making it a great time to secure financing. Leverage the knowledge and expertise of a trained mortgage professional to ensure you are choosing the best option to meet your financial needs.