Mortgage lending can be highly complex, which often leads to confusion and frustration among consumers. Interest rates are a perfect example.
While many organizations advertise extremely low rates, you don’t always get these low rates, and interest advertised by companies is often unattainable to the average consumer.
Mortgage rates are usually around 3, 4, or 5%, yet companies are sometimes advertising rates well below 3%. How is this possible? It’s simple: advertised rates and the actual rate on your mortgage are not always the same.
Interest Rates 101: Understanding the Cost of a Mortgage Loan
How are Rates Determined?
Interest rates, which provide the financial incentive for issuing loans, are based on a wide variety of factors. Some of these factors are in the direct control of the consumer, while others are outside of a homebuyer’s control.
One of the most important factors is the base interest rate set by the Federal Reserve. Essentially, the Federal Reserve determines the rate at which banks can lend money to each other, which sets the foundation for rates that they can lend to consumers. They take into account many factors to set this rate, including the state of the economy and overall demand for lending. This factor is uncontrollable for consumers, but other aspects can be controlled by an individual borrower.
Interest rates on loans vary widely, as the rate is determined by credit score, loan size, DTI, credit history, and more. Essentially, the more of a risk you are to lenders, the higher your interest rate will be. So if you have a low credit score, high amounts of consumer debt (credit cards, car loans, etc.), and need a massive home loan, you can expect a higher interest rate.
All of these factors are essentially jumbled together to determine your interest rate, which is why they will vary widely from one buyer to another. It’s also why advertised rates do not always align with your mortgage.
Advertised Interest Rates: Based on the Best-Case Scenario
There is a simple reality behind advertised rates: they are based on the best possible scenario. To bring people in, advertisers display the best possible interest rate they could offer if a person had a high credit score, excellent payment histories, and a manageable debt load. Unfortunately, not everyone will meet this criteria, which is why some people are surprised to find that the interest rate they are offered does not match with the rate they saw on an advertisement.
Advertised Rates also Assume Mortgage Points
Virtually every borrower knows they will need a downpayment. Unless you are using a VA loan or a USDA loan, you can assume that some sort of downpayment will be required, and this assumption is essentially worked into advertised rates. However, some advertised rates also assume that the borrower will bring cash to purchase mortgage points.
Mortgage points are an upfront and additional payment made towards the loan that helps reduce the interest rate. Essentially, you are paying more from the beginning to pay less in interest, which is effective if you plan on keeping the home for years and have the cash in savings.
However, many people are surprised when they discuss low interest rates with a lender only to find out that an additional $2,000, $3,000, or $4,000 (or more) is needed to reach these low interest rates.
Advertised Interest Rates: General Examples
Every company is different, every borrower has a different profile, and the variation between advertised rates and the actual rate on your loan could be minimal or significant. However, here are a few generalized examples of how rates can be determined and how the small print can make a huge difference on your loan.
Note: These are examples only and do not reflect specific or permanent offers from our team or other companies.
Fixed-Rate, 30-Year Loan Advertised as 2.87%
You may find companies offering a 30-year loan with a fixed rate of roughly 2.87% and an APR of about 3.26%, give of take. On a mortgage of roughly $250,000, you’d be looking at payment of over $1,000, possibly close to or above $1,1000 a month. This monthly payment, however, does not include taxes and insurance premiums, so it’s not an accurate reflection of your total housing costs. It’s also likely that this payment assumes a downpayment of about 8% or 9%, which is not always the case for most loans.
But there could be a major catch with these rates. In the fine print, you’ll find that these low rates are only achievable if you pay for 2 mortgage points, which would cost roughly $5,000, give or take a few hundred. The rate sounds fantastic, but then you learn you need about five grand to secure this interest.
Fixed-Rate, 15-Year Loan with Advertised Rate of 2.25%
15-year mortgages often have even lower rates than 30-year mortgages, and the advertised interest for these loans can be even more enticing. For example, you may see an interest rate advertised as 2.25% on a 15-year mortgage. At about $250,000, this would bring a mortgage payment somewhere around $1,700. But again, this payment does not include taxes and insurance, and the upfront, bold-print advertised content does not include mortgage points. To achieve this extremely low rate, you will probably need about $4,500 in mortgage points, in addition to your downpayment.
As you can see, it’s important that you read the fine print and legal disclosures on all loan advertisements, especially on products that are pitched as a “low-interest” option. There is nothing disingenuous, and it’s not an unethical “bait-and-switch” tactic, it’s just that the low interest rates pitched by companies come with additional costs and are, essentially, a best-case scenario. Yes, you can reach these low rates, but it will take excellent credit, a low DTI, and additional cash.
Honest Service, Clear Communication
It’s important that you work with a lending agent who values clear, honest, upfront communication.
If you are ready for an affordable mortgage with a reasonable interest rate, contact our staff today. We’ll help you find the right loan for your specific needs, and we’ll help you understand the interest rate on your mortgage so you are fully informed on the process and the rate.
You deserve clear, reliable service for your mortgage, so contact our staff today!
