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How Mortgage Interest Rates Work

March 08, 2021

Your home loan interest rate helps cover costs the lender acquires by financing your loan, and can affect how much house you can afford.

When you get a mortgage loan, you’ll be required to pay interest on this loan. Your interest rate is a small percentage of your total loan, paid monthly with your principal mortgage payment. This is put in place to cover the costs mortgage lenders incur for financing your loan.

The interest rate you’re eligible for depends on both the current market conditions and your overall financial situation – like your credit score, debt-to-income ratio, etc.

Mortgage Interest Rate vs. APR

As previously mentioned, the interest rate you lock in on your mortgage is the cost you’ll pay to borrow that money. This will be determined when you begin the mortgage process.

The APR, short for Annual Percentage Rate, is the final amount of interest you’ll pay. This includes not only the pre-determined interest rate, but also additional costs and fees the lender incurs (such as origination fees, closing costs, rebates, etc.). It tends to be slightly higher than the original interest rate you locked in, but typically nothing major.

Mortgage Loan Amortization

To put it in layman’s terms, mortgage amortization refers to how your home loan is paid down – AKA a breakdown of what percentage of your monthly payment goes toward the principal loan payment, and what percentage goes toward interest.

Take a look at our Amortization Calculator to see how this works. It gives you a clear picture of how your mortgage will be paid down over the life of your loan.

Fixed- vs. Adjustable-Rate Mortgage Loans

When you get a mortgage loan, you can choose either fixed-rate or adjustable-rate.

Fixed-Rate Home Loans

If you have a fixed-rate mortgage loan, your interest rate will stay the same throughout the entire life of your loan. Whatever you lock in at the start will be what you pay every month until your mortgage is paid off. This is a great option for many homebuyers because it provides stability and predictability.

Adjustable-Rate Mortgages

An adjustable-rate mortgage (ARM), on the other hand, means your mortgage loan interest rate could change after a period of time. You’ll have a fixed interest rate for the first 5-10 years (depending on the specific type of loan you choose), then after that it may change every year. Whether or not it changes is based on an “ARM index.”

ARMs typically offer a lower initial interest rate than most fixed-rate loans, making them a great option for short-term homeownership (i.e., you plan to sell the home in the next 5-10 years). This also may be an ideal choice for first-time homebuyers who plan to have an increased income several years from now.

Why Your Interest Rate Matters

The difference between 3% and 4% might not seem like much. However, a difference in just 1% on your interest rate can account for thousands of dollars over the life of your home loan.

For example, let’s say you want your monthly principal and interest payment (not including Private Mortgage Insurance, HOA fees, property taxes, homeowners insurance, etc.) to be around $1,000. 

If you’ve locked in a 3.00% interest rate, that means you can take out a loan of $237,185 and keep your monthly principal and interest at $1,000. If you locked in a 4.00% interest rate, you’d only be able to finance $209,460 to keep your principal and interest payment at $1,000, and so on and so forth.

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Example: $1,000 Monthly Principal and Interest

Let’s say you want your monthly principal and interest payment to be $1,200.

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Example: $1,200 Monthly Principal and Interest

As you can see, the corresponding loan amount for a $1,000 or $1,200 principal and interest payment dwindles as rates increase.

History is rife with many examples of cyclicality in rates. Many economists expect inflation and interest rates to rise significantly once the real impact of all the monetary stimulus (money printing) is realized. 

Locking in a rate as soon as you can and owning assets like real estate and other commodities may safeguard you from rising rates and prices in the future. Plus, you’ll be able to achieve the American dream of homeownership at a more affordable price.

Find a mortgage professional in your area to discuss today’s interest rates and how you can achieve your homeownership goals.

APR incorporates our national average origination fee for a conventional mortgage loan. Fees for a conventional loan can go as high as $2601 – closing costs vary based on geographic location. Payment and APR amounts include principal and interest for a 30-year fixed rate, conventional mortgage loan at 95% loan-to-value. They do not include property taxes, homeowner's or mortgage insurance - the inclusion of which would cause the monthly payment to increase. Interest rates shown are examples and provided only to demonstrate how rising rates can negatively impact affordability. All loan requests are subject to credit approval as well as specific program requirements and guidelines. For some programs, income and property restrictions may apply. Information is subject to change without notice. This is not an offer for extension of credit or a commitment to lend.