What Determines Interest Rates? -

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What Determines Interest Rates?

04-12-2022 • MHS Lending

Interest is the price you pay to borrow money and interest rates are a certain percentage of the total loan amount that is paid back to the lender. These rates can affect the affordability of a home as the lower the interest rate is, the lower the monthly payment is. These rates fluctuate often based on a few specific reasons and eligible military families and veterans are at an advantage in competitive housing markets due to the fact that VA Loans traditionally have lower interest rates than other loan products.

Outside factors that affect interest rates

There are a few factors that come into play when interest rates are set. Here are a few of the most common outside factors:

  • Federal Reserve: while the federal reserve does not set mortgage rates, they do affect them. The Fed controls short-term rates by increasing or decreasing them based on the state of the economy in order to control the money supply. When the economy is struggling, like it was during the early days of COVID-19, the rates were lowered, and historically low rates were offered in 2020 / 2021.

  • Bond Market: mortgage rates have a reputation of being tied to the 10-year Treasury note when tied to the bond market. Bonds affect mortgage rates depending on their demand. When the demand is high, rates increase and vice versa.

  • Inflation: Investopedia states that the higher the inflation rate, the more interest rates are likely to rise. They say this occurs because lenders will demand higher interest rates as compensation for the decrease in purchasing power of the money they are paid in the future (over the life of the loan).

Other factors

There are a few additional factors that could affect your interest rate. First is the length of the loan. The shorter the length of the loan, the lower your rate will be. While 30 years is still the traditional length when it comes to home loans, homeowners who can afford a 15-year or 20-year mortgage will likely have a lower interest rate because it costs lenders more to lend money for 30 years versus 15 or 20.

Another factor that could help you get a better interest rate is by having good credit. Experian states that people with higher credit scores tend to consistently pay back debts on time as agreed, so they typically get the lowest interest rates. Their proven history with credit is more desired by lenders, who are always looking to minimize risk.

Fixed vs. adjustable rates

While interest rates are applied to almost any type of loan or line of credit (credit cards, student loans, etc.) mortgage payments typically have two types of rates: fixed rates or adjustable rates. Fixed rates are the same throughout the life of the loan, making it easy to budget and simple to track and are often higher than adjustable rates at first. Adjustable rates (ARMs) are typically lower than fixed rates at the start of a loan as they are set below the market rate. While they are lower at first, ARMs are subject to change throughout the life of the loan and therefore are much more complicated to track over time.

Benefits of the VA Loan when it comes to interest rates

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. If you’re looking to learn more about VA Loans and want to get pre-approved by our team at MHS Lending, click here to get started!