If your loan amount is more than the conforming loan limits, your loan interest rate might increase. The conforming loan limits are set by federal agencies and adjusted every year. Currently, the limit is $320,000 - so if your loan amount (not home value amount) is more than that, you will likely pay a somewhat higher interest rate.
When determining an interest rate, a mortgage company must consider different types of risk. One type of risk is the likelihood that a particular borrower will pay back the loan in a timely manner. This is where a good credit history can be important; if you credit is less than perfect, you may get a higher interest rate or have to pay more closing costs. Another important factor is debt to income ratio. A borrower with a high level of debt is seen as statistically more likely to default on loan payments. The added risk for this type of situation means the lending institution will need to charge a higher interest rate.
Another type of risk is the anticipated future market interest rate fluctuations. When making long term loans, a lending institution must try to anticipate what might happen with the market interest rate over the lifetime of a loan. The longer the loan, the greater the uncertainty about what may happen to rates over the period of the loan. One way to secure a lower interest rate is to choose a shorter term loan, such as a 15 or 20 year payback period. Mortgage companies can generally give a lower interest rate for these loans, because there is a shorter period of time for market interest rates to fluctuate.
Home purchases made with little or no down payment are also seen as riskier by lending institutions. If a borrower were to default on a loan where there is no equity, then the bank is more likely to lose money through the foreclosure process. This added risk corresponds to higher interest rates for loans with a low down payment. So the best rates can be obtained with a minimum 20% down.
One more thing to keep in mind when looking for the best interest rate is closing costs. Many mortgage companies have started paying some or all loan closing costs in order to attract customers. But you actually end up paying those costs through a slight increase in interest rate.
Debt to income ratio will also have an affect on your interest rate. If you have a lot of debt, you may be seen as a riskier prospect, and therefore you will get a higher interest rate. Try to pay off all other debt in order to get the best possible home mortgage rate.
As there are many types of borrowers with different needs, mortgage lenders have created many loan programs to try to meet those needs. Here are some of the most common types.
Conventional loans
This has been the most popular loan type, and is most useful if you think you are going to stay in your home for a long period of time (at least five years). A conventional loan usually requires at least a 10% down payment.
If you are going to buy your first home, it can often be difficult to save a significant down payment. There are a number of loan programs specifically tailored for this situation. One government program is administered by the Federal Housing Administration and is known as an FHA loan. The FHA actually guarantees this type of loan, so that lenders get paid back if the borrower defaults. FHA loans can require only a 3% down payment, or possibly even less. FHA loans have limitations on size, and are more expensive because they require mortgage insurance, which adds to the overall cost of the loan. With FHA loans, many of the closing costs (including the initial mortgage insurance premium) can be added to the loan amount, reducing the need for more cash at purchase time.
Many conventional loans require that down payment funds come from income savings or from the sale of another property. These programs often require proof of the source of down payment funds. An FHA loan allows gift funds to be use for the down payment, and no verification of source is required. The source of the donor is restricted to family members and a few types of organizations.
Conventional loans (continued)
Mortgage insurance for FHA loans currently require a 1.5% premium to be paid at purchase time, and a renewal premium of 0.5% every year of the loan term. On a non-FHA conventional loan, the mortgage insurance premium can be as low as 0.5% and renewals as low as 0.3% during the loan term. If the down payment is large enough, mortgage insurance may not be required at all. Many borrowers will pay mortgage insurance for the first few years of the loan, but when enough equity has accumulated, they will re-finance their loan in order to stop paying the mortgage insurance renewal.
Veterans Administration Loan. If you are a veteran you may qualify for a Veterans Administration (VA) loan. VA loans require no down payment inmost cases, and you don’t have to pay a monthly mortgage insurance premium. Many mortgage lenders are prepared to help you get a VA loan.