Mortgages can be quite complex, and each component plays an important role, but the most effective way to save money on a home loan is by finding the best interest rate. However, in order to find the best interest rate, it is first necessary to understand what it is, how it is determined and how it is applied in each type of home loan.
Interest Rate Basics
The interest rate of the mortgage is the percentage of the principal paid to the lender for originating the loan. This rate is per year, but it is usually compounded monthly. This means that if you have a low interest rate, you will either have lower monthly payments or be able to take out a larger loan.
Interest rates are determined, primarily, by the financial markets, but several other factors go into each specific interest rate. Market interest rates can fluctuate throughout the year, month or even by the hour. In addition, the amount of risk the lender is taking by agreeing to the loan plays a large role. Risk factors include the type of structure, location, down payment and borrower’s credit rating. Ideally, to get the best interest rate, you need to have good credit and buy a new home in a safe area with a large down payment.
Types of Mortgages
The lowest interest rate is not always the best interest rate. The type of loan and the term of the loan must also be considered. Different types of home loans apply interest rates in different ways, but the two most common are the fixed-rate mortgage and the adjustable-rate mortgage.
In a fixed-rate mortgage, the interest rate stays the same throughout the term of the loan. Homeowners who lock in an interest rate when the market is low benefit the most from this type of mortgage.
In an adjustable-rate mortgage, the initial interest rate is usually lower than in a comparable fixed-rate mortgage. However, the rate may change periodically to reflect current market conditions.
One way to get a low interest rate is to buy discount points from the lender. Points are purchased by paying a fee to the lender with the down payment for the home. For each point purchased, the interest rate is reduced by 1 percent over the lifetime of the loan. In the long run, buying points could end up saving you thousands of dollars. However be sure to consult with your respective mortgage broker in order to get the best deal available.