Mortgage Interest Rates and How They Work

Buying a home with a mortgage is probably the largest financial transaction you will enter into. Typically, a bank or mortgage lender will finance 80% of the price of the home, and you agree to pay it back—with interest—over a specific period. As you are comparing lenders, mortgage rates, and options, it’s helpful to understand how interest accrues each month and is paid.

What is a Mortgage Interest Rate?

Mortgage interest rates a percentage of your total loan balance. It's paid every month, along with your principal payment, until your loan is paid off.

Your mortgage interest rate is what it costs you each month to finance your property. It's an extra amount you must pay to your lender in addition to paying off the amount that you've borrowed. Your interest rate is effectively the lender's compensation for letting you use its money to purchase your property.

How does mortgage interest work?

Mortgage interest rates can vacillate depending on larger economic factors and investment activity. The secondary market plays a role. Fannie Mae and Freddie Mac bundle mortgage loans and sell them to investors looking to make a profit. Whatever interest rate those investors are willing to pay for mortgage-backed securities determines what rates lenders can set on their loans.

Mortgage Interest decrease when…

• The stock market falters.

• There are dips or insecurities in foreign markets.

• Inflation slows.

• Unemployment increases or jobs decrease.

Mortgage Interest increase when…

• The stock market is strong.

• Foreign markets are strong and stable.

• Inflation is up.

• Unemployment is low and jobs are increasing.

Effect of Mortgage Interest Rates on the Market

Mortgage rates don’t directly impact home prices, but they do influence housing supply—which plays a big role in pricing. As mortgage rates rise, existing homeowners are less likely to list their properties and enter the market. This creates a dearth of for-sale properties, driving demand up and prices with them.

When rates are low, homeowners are more comfortable selling their properties. This sends inventory up and turns the market in the buyer’s favor, meaning more options and more negotiating power.

It depends on how much rates rise, however. It can stifle demand if rates rise for too long or get too high—even for the few properties that are out there. That would force sellers to lower their prices to stand out.

How you are given your interest rate

The rate you’re given is going to be based on multiple factors. They may include:

• Your credit scores

• If you’ve had any bankruptcies or other financial events

• Your income and employment history

• Your debts

• Your cash reserves and assets

• The size of your down payment

• Your loan type, term, and amount

In general, the bigger the risk the lender sees in approving you for a mortgage, the higher your interest rate will be. However, keep in mind, different lenders may offer you different rates, which is why it’s important to shop around for a loan.