How Do Interest Rates Work?
08-19-2021 • MHS Lending
Buying a new house is one of the most rewarding and exciting purchases you can make and as a first-time homebuyer it’s important to understand the ins and outs of the transaction. This large purchase is not only a commitment to pay the negotiated price of the home, but it’s also a commitment to pay your lender or bank the interest they charge for approving your loan. A lot of homebuyers don’t know exactly how interest works, so we broke it down here in an easy-to-follow guide below.
What is an interest rate?
An interest rate is the amount a lender or bank charges a borrower and is a percentage of the principal (the amount loaned). Interest rates are calculated as a percentage of the total amount borrowed and are determined during the home buying process. These fees are charged on top of the principal as a payment for using the lender's assets to purchase a home. Each month, mortgage payments are bundled with additional fees including taxes, insurance, and interest and these rates are determined during the home buying process so buyers are confident they can afford to pay for the house they’re buying.
How are interest rates set?
According to Investopedia, lenders and banks can assess the risk of the borrower when setting the rate which can often be determined by their credit score. When a borrower is considered to be low risk by the lender (is likely to make on-time payments throughout the duration of the loan) the borrower will usually be charged a lower interest rate. Alternatively, if a borrower is considered high risk (sometimes due to a history of late payments), the rate may be higher.
Other factors that go into determining interest rates include the borrower's credit score, current market conditions, type of loan, and duration of loan. Once your rate is determined and you are under contract on a house, the rate can be locked so you know what to expect at closing.
How do interest rates affect monthly payments?
The rate is set once the loan is closed and is applied to the total amount of the loan. The bank or lender applies the interest rate to the loan balance with each payment. While interest rates are applied to almost any type of loan (credit card, education, etc.) mortgage payments typically have two types of rates: fixed rates or variable rates. Fixed rates are the same rates throughout the entire life of the loan and variable rates are subject to change throughout the life of the loan.
Interest rates with the VA Loan
The VA Home Loan is a powerful loan that is backed by the Department of Veterans Affairs. Because the loan is insured by the government, VA-approved lenders are able to charge some of the lowest interest rates on the market. These rates are often much lower than rates you would receive with a conventional mortgage. While the VA doesn’t set the interest rates, approved lenders combine the borrower's credit score, loan type and duration, and current market conditions to offer low interest rates on VA-backed loans.
It’s important to note that while VA loan rates are generally lower than other loans, they often differ between purchase loans and refinance loans. Approved lenders can help you navigate the rates while you are buying a home or refinancing an existing loan. Our team at MHS Lending specialize in working with military families and veterans and will help you navigate the home buying or refinance process every step of the way. If you’re ready to start your home buying journey today and want to learn more about the VA Loan, give us a call at 619-728-7620.