How Mortgage Interest Works

Knowing how mortgage interest works is pretty important when you buy a house. Your mortgage rate is one of the main things that determine how much you’ll be paying every month towards the home. 

 

So how exactly does it work? Let’s take a look. 

 

How Mortgage Interest Works – The Basics

As you probably already know, very few people pay with cash when buying a home. A mortgage just makes sense because it lets you borrow money at relatively low-interest rates. 

 

The interest rate is there so the bank can actually make money. It’s the lender’s way of getting compensated for the risk they’re taking by giving you the loan. The lender can borrow money at a certain interest rate, then they use that money to offer mortgages to home buyers such as yourself. They charge a higher interest rate than they’re paying, and they are making a profit off the difference. 

 

How Does Mortgage Interest Affect the Monthly Payment?

It’s been an interesting year in real estate. Home prices went up 19.7% since last November. A lot of home buyers were struggling to get a winning bid because there was a ton of competition from other buyers, including investors. 

 

Why has the market been so crazy? Namely because of one thing: low-interest rates. Both home buyers and investors knew it’s a good thing to buy a home while mortgage interest rates are low. 

 

Here’s a simple exercise with numbers to show how the rate makes such a big difference. 

 

A 30 year, fixed-rate $300,000 loan at a 3.8% interest rate would set you back about $1,806 per month. The same $300,000 loan at 3.1% interest rate is about $1,689 per month. 

 

What’s the big deal about saving $117 per month? That comes out to $42,120 over the lifetime of the loan!

 

Think about that from an investor’s standpoint as well. The lower payment makes it easier to reach positive cash flow. Plus when they’re saving tens of thousands of dollars on a lot of homes, it really adds up to a ton of money saved in the long run. 

How is the Mortgage Interest Rate Determined?

Your lender will determine what type of interest rate to offer you. The mortgage rate they offer will be based on several things. 

 

• Your credit score and history. The better your credit, the lower your rate. 
• The length of the loan. A 15-year mortgage generally has a lower rate than a 30 year.
• Which type of mortgage you take out. An adjustable-rate mortgage (ARM) has a lower initial rate than a fixed-rate mortgage. 
• Employment history – lenders want someone who has stable employment
• Market rates – your lender wants to be competitive while also making sure they cover their own expenses

 

Keep these factors in mind as you shop for your loan. While you can’t affect the market rates, you can affect just about everything else so consider your loan options and how you can improve employment and credit history to get the best rates. 

 

How Mortgage Interest Works vs APR

You may have heard the term APR in the mortgage world. APR stands for Annual Percentage Rate and exists to show a clearer picture to the borrower so they understand how much they are really paying. Unlike the interest rate, the APR includes fees such as closing costs, mortgage insurance, and loan origination fees. 

 

When you’re considering loan options, make sure you look at both the interest rate and the APR, since this will give you the most complete picture of how much you’re paying every year. 

 

Conclusion

Do you have any other questions about how mortgage interest works? Send us an email at [email protected] – we’d love to hear from you!