What is an interest rate, and how does it work?

Most potential home buyers require a mortgage to finance the purchase of a home or property. Under a mortgage agreement, the borrower agrees to make regular payments to the lender for a specific number of years until the loan is paid in full or refinanced. The mortgage payment includes a principal portion plus interest. Mortgage interest is what it costs to borrow money. The gift of cash costs the borrower, and the cost of borrowing is called an interest rate. Let’s pretend you’ve received approval for a 30-year loan at 5% interest. This approval means a lender has agreed to give you $100,00.00 over 30 years, and the cost to borrow is 5%. At 5% interest, the cost of borrowing $100,000.00 is 5,000.00. Ultimately, this means that at the end of the 30 years, you will spend 105,000.00 repaying the lender.

Calculating monthly interest payments

Calculating monthly loan interest can be intimidating and complex as some types require different math levels. You will most likely use a fixed interest rate when calculating loan interest. Fixed interest rates do not change for the life of the loan.  The central part of your mortgage payment is the principal and interest. During the earlier part of the mortgage loan, most of a property owner’s payment goes toward interest versus the principal balance. As the age of the loan increases, more of the payment is applied to the principal balance until it’s completely paid off. The principle is the amount you borrowed from the lender, in this case, $100,000.00. The interest is what the lender charges you to lend you the money, in this case, 5%. 5 divided by 100 is 0.05. 0.05 x the principal ($100,000.00) is 5,000. Now we understand that over 30 years, the borrower will pay $5,000.00 in interest. To determine how much of the monthly payment is interest, divide the total amount of interest, 5000.00, by the total amount of months on the loan. In a 30-year loan, there are 360 months, so we would divide 5000.00 by 360 months which equals around $14.00. After calculating, the borrower understands that $14.00 of the monthly payment goes toward the interest.

Types Of Interest Rates

Consumers who want predictability in their payments prefer fixed mortgage interest options because they don’t come with the highs and lows associated with floating or variable rates. Many mortgagors opt for fixed rates when interest rates are low because if rates go up, their interest rate stays the same. Fixed rates frequently have long-term financing that lasts as long as 30 years. Variable mortgage interest rates change based on the market. These rates are also known as floating or adjustable rates. Variable rates go up or down based on fluctuations in the market. The variable interest rate also changes when the underlying index or rate changes. So, a mortgagor’s payment decreases when the rate drops and increases when the rates rise. Variable mortgage interest rates are great options for short-term financing or when a consumer plans to refinance after a certain period.

Controllable Factors that Determine Interest Rate

To some degree, prospective buyers can affect the interest rates based on their credit standing. In the US, credit scores and credit reports provide information about each borrower so the lenders can assess how much risk they will take by engaging with the potential borrower. A credit score between 300 and 850 represents a borrower‘s creditworthiness; the higher, the better. Build your credit score by making on-time payments over a substantial period. Credit scores drop due to late payments, high credit utilization, high total debt, or when bankruptcies are involved. The average credit score in the US is around 700. Anything above 750 is considered excellent and will receive the best interest rates. Typically, a lender does not trust a buyer with an undesirable credit score and will charge them more money to borrow. For example, if you receive approval for a 30-year loan of $100,000.00 at 20% interest, you will spend 120,000.00 by the end of the loan term. The lender is charging you 20% of the loan amount. 20,000.00 over 30 years is (hypothetically) what it will cost a buyer to finance your property. A higher interest rate protects the lender from a borrower likely to default.

Increase Your Odds of a Winning Offer

Purchasing your dream home shouldn’t be stressful. United Wholesale Lending can simplify the homebuying process and increase your odds of a winning offer. Browse our website to learn more about improving your chances of landing your dream home. We are always available to answer questions and help you obtain the financing you need. Reach out directly by calling 800-869-2608.