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How Do Banks Settle Upon The Rate For A Mortgage?
If you are shopping for a mortgage, you of course want the best possible rate. This is a decision that you will live with for a long time. How do the banks determine the rate they quote you in the first place?
There are some factors that determine the interest rate that you can control, and some that are completely out of your control. It is a good idea to recognize the difference.
The first and foremost determinant of the interest rate on a loan is the credit standing of the borrower. This is an issue that is in the headlines all the time, and everyone who is looking to purchase a home is concerned about their “FICO” numbers.
The idea behind a FICO score is that private agencies do an analysis on a borrower’s credit profile to determine the chances that he will be able to pay the loan. Banks all use the services of these credit rating agencies to find out the assumed risk of lending to a borrower and the criteria the agencies use are history of payments, exposure to debt, income, job history, etc.
An important factor also is the size of the down payment on the house.
The larger the deposit, the less exposure the lender has. In addition, the more you are willing to put down indicates to the bank that you are willing to be just as committed to this property as they are.
This means that the bank can consider you a better risk and will lower your mortgage rate. The problems most home buyers have, however, is deciding between saving the deposit and continuing to pay rent. The longer you pay rent, the longer you can wait and save the money for the down payment, but couldn’t rent money just as well be a mortgage payment?
The next factor that will be used to determine the rate is the length of the mortgage. If a bank has to commit for a longer time, they are going to price that additional exposure into the loan rate.
Taking a shorter maturity on your mortgage, such as a five year loan instead of a 25 year traditional loan will result in a lower rate for you. But for the borrower, it may be worth while to take the higher interest and not have to be concerned about increases.
This is one of the other important factors in what determines interest rates: What the general market is doing. Banks have to get their money from other sources, so the more they have to pay to obtain money, the more they have to pay to lend it. If general interest rates are rising, mortgage rates will rise. Whether interest rates will go up or down is a topic under constant study and discussion by economists.
Most people would rather take a chance on a fixed rate that can’t increase, than a rate that changes periodically. Even if rates go down, they feel the risk is better to have a locked in rate than a changing rate.
The size of your mortgage is the last criteria used in determining rates. There are limits that some banks have on the level of the loans they can hold in their portfolio, and if they have to have larger ones than the limit, they will impose a penalty in the form of an increased interest rate.
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