How do mortgage companies determine your interest rate?
Many factors that are considered when determining the rate you're receiving on a mortgage. I will discuss three main factors that affect the rate that you receive.
If you have good credit and your monthly income far surpasses your monthly debt obligations, you will get approved at a lower interest rate. However, if your monthly income barely covers your minimum debt obligations, even if you have a credit, you will not receive the lowest available interest rate. Your credit rating is primarily based on your payment history, how much debt you have, and your credit utilization (are any accounts "maxed out") among many other smaller variables. If your credit is poor, you may want to try to clean up any trouble spots on your credit report by paying-down debts, or re-establish a positive payment history. This doesn't mean you can't get a loan, it just means that your loan to value and debt to income will be important variables for getting your loan completed.
The loan-to-value (LTV) ratio is the amount of a mortgage as a percentage of the total appraised value of the property. For instance, if a borrower wants $80,000 to purchase a house worth $120,000, the LTV ratio is $80,000/$120,000 or 66.66%. Loan to value is one of the key risk factors that lenders assess when qualifying borrowers for a mortgage. The risk of default is always at the forefront of lending decisions, and the likelihood of a lender absorbing a loss in the foreclosure process increases as the amount of equity decreases. Therefore, as the LTV ratio of a loan increases, the qualification guidelines for certain mortgage programs become much more strict. Lenders can require borrowers of high LTV loans to buy mortgage insurance to protect the lender from the buyer default, which increases the costs of the mortgage. A larger down payment (greater than 20%) will give you the best possible rate. Down payments of 5% or less should expect to pay a higher rate as you are starting with less equity as collateral.
Debt to Income (DTI) is a variable that lenders use to see your ability to make payments on your loan - it literally means the percent of your income that will be used to make your debt payments. A Debt to Income Ratio is a calculation used to determine if the income of a potential borrower qualifies for a mortgage loan. The way to calculate your own Debt to Income Ratio is to take all of your monthly debt payments (minimum credit card payments, car payments, student loan payments, current and/or proposed mortgage payments including taxes and insurance) and divide that number by your monthly income. For example, if the total of your credit card payments, student loan payments and mortgage payment equals $4,500, and you make $10,000 a month, then your Debt to Income ratio is 45%. If you have a high DTI expect to pay more on your interest rate.
There are several other factors used in determining your mortgage rates and each application for a mortgage is unique by itself. For more information on mortgages, please visit the mortgage information page on our website.
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