Step One: Understand how Mortgage Interest Rates are Calculated



The Federal Reserve is an institution which keeps the economy ticking over without excessive inflation, by setting figures called the federal funds rate (the interest rate banks charge each other) and the discount rate (the interest rate the Federal Reserve changes to lenders). The interest rates that are set by the Federal Reserve directly impact federal interest rates, and in turn, federal interest rates influence the rates that lenders quote to mortgage applicants.

When the economy is slow, for example, the Federal Reserve tends to respond by lowering federal interest rates. This allows institutions to borrow from each other, and from the Federal Reserve, at lower interest rates. In turn, lenders reduce the interest rates on the mortgages they offer to their customers. The result is that more people can afford to obtain a mortgage, more homes are bought and sold, and the economy receives a much-needed boost.

Most banks and other lending institutions update their mortgage interest rates at least once per day. The rates are calculated on the basis of Federal Reserve interest rates as well as other factors that represent the lender's costs of loaning money to a mortgage applicant. Most lenders have similar costs, and these rates are usually very similar between various lenders.

So why are there differences in mortgage interest rates? Because when you receive a quote from a loan officer, you are being quoted a figure that represents the Federal Reserve rate, the lender's costs, and the loan officer's profit margin. Most lending institutions have a minimum interest rate and a maximum interest rate, and allow lending officers some flexibility in choosing the rates they set, and determining their own profit margin.

Essentially, this means that when you are quoted a significantly higher interest rate at one institution, it means that they are charging a higher profit margin, and more of your money is going into the loan officer's pocket.

Step Two: Shop for Low Rates

When you start shopping for a mortgage, your objective is usually to find the best interest rate possible. Getting the low interest rate you want is not just about shopping around, but this step definitely is an important one.

The most important thing to understand is that lender quotes are not always going to be reliable. Lenders need people to lend to, and they are under pressure to quote good rates to get you interested, but the rates they quote are not necessarily the final amount you will have to pay. There are other factors involved as well.

All lenders are required by law to provide you with a Good Faith Estimate within three days of your mortgage application, but they are not required to provide a guarantee of that estimate. The estimate is worth nothing by itself, so ask lenders if they are willing to provide a guarantee, that is a good sign of honesty, and it helps ensure you will get the quoted rate.

Step Three: Buying Points

Many lenders offer mortgage applicants points, which can be used to buy down the interest rate on the loan. The more points you buy, the lower your interest rate. Buying points is an excellent way of saving money over the life of your mortgage, as long as the lender is not charging an exorbitant amount of money per point. Never assume that buying points will pay off, always check your math to make sure that buying points will save money. It is important to remember that when you buy points you must pay for them in cash when you close on the property.

Step Four: Lock in your Low Interest Rate

When you lock in your interest rate, this means your lender promises in writing to hold your interest rate at the agreed-upon amount until your loan has finished processing. If interest rates rise in the meantime, the borrower retains the lowest interest rate. The downside, of course, is that if interest rates drop, the borrower is locked into the higher rate.

It's crucial to pay very close attention to the market if you decide to try locking in a low rate. If you lock in your interest rate at the right time you can save thousands of dollars over the life of your loan, but if you keep riding the market hoping to hit rock-bottom on the interest rates, you could end up waiting too long.