What Does My Mortgage Interest Rate Mean?

If you follow the news, you’ve probably heard talk of “historic lows” and “raising rates” for real estate transactions. What does all of this rate talk mean?

How is interest rate determined?

Mortgage interest rates are set based on the current financial markets. The Federal Reserve Bank and U.S. Treasury look at how and where people in the United States are spending money. When they set lower interest rates on things like credit cards, car loans, and other short-term items, it has a trickle down effect to longer-term products. Mortgages, which are usually 15 or 30 years, can offer lower interest rates as the market changes.

Keep in mind that individual banks and lenders can offer different products and that factors like your credit and how risky they consider your loan is will impact your individual interest rate. A fixed rate mortgage will also offer different rates than an adjustable rate mortgage. A fixed rate is generally higher to begin but remains the same over the life of the loan.

How is interest paid?

Once you close on the purchase of a new home, you will probably be looking for that first bill to come in the mail. Part of each mortgage payment will go to interest. With a fixed rate mortgage, a big portion of each payment in the beginning will go to paying off interest. As the loan is paid over time, more of each payment goes towards the principal (or initial) value of the loan and less goes towards interest. Meanwhile, the monthly payment amount remains the same.

Want to pay less in interest? Designate extra payments to go towards principal. Using an amortization schedule, you will be able to see exactly how much of each payment goes towards interest and how much goes towards principal. The earlier you start making extra payments, the bigger impact it will have on the overall amount of interest you will pay.