Several factors affect the mortgage borrowing costs of home purchases and refinances. The state of the national economy and international events can cause interest rates to rise overnight. On a smaller scale, a poor credit history and limited assets can increase mortgage costs for individual borrowers. You can minimize mortgage borrowing costs by taking out a loan when interest rates are low and you have a strong down payment or plenty of equity in your home.
Mortgage Borrowing Cost Basics
The most important features of a mortgage that will impact the total cost of borrowing against your house are the interest rates lenders offer and the amount a lender needs you to contribute to the transaction. You must pay loan costs at closing, also known as points, on a refinance or purchase. You must also contribute money out-of-pocket on a purchase for the down payment. In general, the better qualified you are for a loan, the less risk you pose to the lender and the lower your overall mortgage borrowing costs. Having a strong credit score, stable work history and high annual income all work in your favor.
Lending institutions make short-term loans to one another, and mortgage rates tend to increase when lenders' borrowing costs increase. The Federal Reserve, or the Fed, sets a benchmark interest rate for short-term loans, which is known as the Fed Funds Rate. The Fed makes monetary policies that influence credit conditions to maintain economic stability and curb inflation. Although mortgage rates do not move in lock step with the Fed Funds Rate, mortgage lenders and investors may view an increase in the benchmark rate as a sign of inflation and raise their rates as a result.
Lenders may keep rates low to compete for business. As the number of qualified borrowers and demand for their loans rise, so do their rates. Lenders charge origination fees for making loans, administrative fees for processing the paperwork, underwriting fees for analyzing credit and income and fees for credit and appraisal reports. An increase in borrower volume can increase the lender's costs of doing business, which may also result in fee hikes to borrowers.
Your own loan scenario can also raise loan costs. A poor credit history increases the interest rates lenders offer and the costs of bringing the rate down. You can lower the rate by paying discount points to the lender at closing. A down payment of less than 20 percent, or equity of less than 20 percent in a refinance transaction, requires you to pay private mortgage insurance, or PMI. PMI coverage protects the lender in the event you default. The lender typically collects PMI in monthly installments along with your loan payments. In addition, certain property types may cost more to finance due to the increased risk of default they pose. For example, lenders usually charge a higher rate for condominiums -- especially high-rise condos -- as well as two- to four-unit properties and non owner-occupied homes.
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