Taking out a loan is and will forever be the biggest financial transaction you will make in your life. It’s important to understand how interest rates work because it will help you find out if you can afford the mortgage or not.
Typically, a mortgage lender or a bank will offer you 80% of the loan for your home, which you pay back with interest within a specific period. Your mortgage is affected by several other factors than just interest rate. These include the loan type, down payment, credit score, loan term, home location, and home price.
First, let’s take a look at the major factor of home mortgage:
Fixed vs. Adjustable Interest Rate
There are two types of interest rates, which include:
- Fixed-Rate: The interest rate is not subjected to any change.
- Adjustable Interest Rate: The interest rate will change depending on different conditions.
Fixed Interest Rate
Having this type of interest rate offers you the benefit of paying the same monthly payment for the entirety of your loan term. So, whether your loan’s repayment time is 10 years or 30 years, the payments will remain the same.
Here’s an example to help you understand this:
You get a fixed-rate mortgage for $200,000 for 30 years. You will be making a total of 360 monthly payments, with no change in the amount. The annual interest rate is $4.5%, making a monthly payment of $1,013. Homeowner’s insurance, private mortgage insurance, and real estate taxes are not included in this amount. Each month, a 0.375% interest rate will be added to your outstanding loan balance.
After the first payment, since the principal amount will go down, the next monthly payment will be slightly less. By the last payment, you will have paid off the interest and the principal amount.
Adjustable Interest Rate
As the name says, the interest rate on your loan won’t be set for the entire term. There’s a limit on ARMs, and the interest rate does not fluctuate much. When the interest rate changes, the lender recalculates the monthly payment. The principal amount lowers after the first payment, but the interest rate depends on the market.
This interest rate type has one major advantage and disadvantage: If the market drops, the interest rate will be low, allowing you to save a little on the side. However, if the interest rate increases, your carefully planned budget messes up.
Here’s an example to help you understand this:
You get an adjustable mortgage of $200,000 with a loan term of 30 years. You keep the interest rate adjustable for 1 to 5 years. The annual interest rate starts at 4% and remains the same for five years. After that, an increase or decrease in the rate is capped off at 0.25%. For 60 months, the monthly payment is $955. If the interest rate increases by 0.25%, the monthly payment would be $980. A further increase would make the monthly payments as high as $1,005.
Again, homeowner’s insurance, private mortgage insurance, and real estate taxes are not included in this amount.
Other Factors That Affect Mortgage
Down Payment
All home loans require a down payment. The higher the down payment, the lower the interest rate will be. A 20% down payment is ideal for a house that costs between $250,000 and $300,000.
Credit Score
Your credit score and credit history ensure the lender that you will make the monthly payments on time. If your credit score falls in the “Poor” range, the lender will offer you a high-interest rate, and the loan will come with a few restrictions.
Loan Term
If your loan term is 30 years, your monthly payments will be low. However, you will be paying more in interest rate. On the other hand, your monthly payments will be high if your loan term is less than 20 years. Still, this way, you will pay less in interest rate. It’s all about balancing your paycheck and budget other expenses to put the necessary ones first.
How interest rate affects your mortgage differs from loan to loan. For example, an FHA loan comes with a low-interest rate and does require a 20% down payment. However, its eligibility criteria are strict. When talking about conventional loans, both the interest rate and down payment requirements are high.
If you are buying a home in South Florida, get in touch with Ace Mortgage Loan Corp. to determine how big of a mortgage you can qualify for. Dial (954) 777-7447 now and talk to their financial planner to find out what loan type will suit you best.