Who decides your loan's interest rate?

Although lenders themselves set the terms of your mortgage, the interest rate is largely decided by the financial market at large.

This page:

  • Briefly describes how mortgage interest rates are set

  • Begins to explain how your credit affects your interest rate

  • Helps you decide what type of mortgage is a good fit for you

The first part of this guide explains what a mortgage is, what the differences are between various types of mortgages and how to choose the best loan for you.

The second part of this Mortgage Basics Guide describes what goes into your mortgage package: points, interest, insurance, etc.

Who decides your mortgage's interest rate?

Very few lenders actually keep the mortgages they fund. Most are sold to and held by mortgage investors or are bundled into mortgage-backed securities which are then resold to mutual funds, Wall Street firms or financial investors.

Because the demand for and price of mortgages is largely determined by the market, the difference in interest rates from lender to lender should not be that great.

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Of course, you still want to find the lowest rate possible. Eloan guarantees the lowest rates for prime borrowers, whereas if you have "problem credit" FullSpectrum Lending will give you the best sub prime rate in the country.

The interest rate you'll pay is made up of an index rate plus a margin. The margin will be a few percentage points, and it's what makes the lender a profit on lending to you. In an ARM, this is the adjustable part of your interest rate.

An index rate reflects how much it costs the bank to lend you money. Common indexes used in mortgages are the Treasury Securities index, the Average Mortgage Rate, the LIBOR, and the COFI rate.

Different mortgages will use different indexes, and some are more stable than others.

But let's get back to our discussion.

The more of a risk you represent to the lender (because of poor credit history or small down payment, for example), the higher the margin the lender will charge you. A risky investment needs higher returns to make it worthwhile. If you think that this may apply to you, find out more about special mortgages.

So how does the interest rate affect your choice of mortgage?

This is simple enough on a fixed rate mortgage. It is the percentage rate at which your mortgage will be amortized over its life, with no variation. It is made up of an index rate plus a margin. What index the lender uses and the size of the margin added are not really important in FRMs, because your rate won't change even if the index rate soars.

With an FRM, your only concern is the interest rate quoted now: the lower the better.

It's not so simple with an adjustable rate mortgage. Here, the interest rate you're quoted will only apply to the initial fixed period. This rate will often be quite low, particularly if the fixed-rate period is short. If you're planning on reselling your new home soon (around the time the low "teaser" rate expires), this initial rate may be your primary concern. If not, you'll want to dig a little deeper.

As you dig further into your loan's details, you'll find the index and margin the ARM will follow for the rest of its life. Often a lender will show a chart or list comparing the initial fixed rate with a projected estimate of the rate after that period.

No one really knows for sure what a rate will do in the future, but it's important to note what the rate is expected to do, and the size of the margin the lender is charging.

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After you apply at Eloan, you will be presented with all of the personalized interest rate information you'll need to evaluate the cost of your loan. Chances are, you will be pleasantly surprised. And if your credit is keeping you from getting good deals elsewhere, Full Spectrum Lending will also give you a nice surprise: their sub prime loan rates are lowest in the country.

Lenders will also provide you with an annual percentage rate, or APR. The APR is intended to express the total cost of the mortgage over its life, including interest, lender fees, and discount points. However, paying too much attention to this can be misleading because the fees included in this number vary from lender to lender (and sometimes from mortgage to mortgage).

This is just one of the things to consider when choosing between an FRM and ARM. In the next two pages, we'll discuss fixed mortgages and adjustable mortgages in detail, to help you decide which type is right for you.

Next: What types of mortgages are there?

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