Mortgage Interest Rate Basics

At Local Mortgage, our team is passionate about helping people get into the home of their dreams and save money in the process. Our site has several features to help you through your mortgage calculations, and we try to answer any questions you may have about the process of using a mortgage to buy a house. To that end, you may be wondering what makes a good interest rate for your mortgage.

Many people have an intuitive understanding that interest rates are crucial to mortgages and that they affect the monthly payment you end up making. That said, interest rates are often discussed without an explanation of what they are. Since many financial advisors work with interest rates everyday, they don’t take the time to help their clients gain a solid understanding of the function rates perform. We are here to change that.

In today’s blog, we will discuss the basics of interest rates, what makes one good, give you an idea of how to find good interest rates, and try to give some context to modern interest rates by discussing the history of mortgage rates in the United States. If you are a first time homeowner or looking to refinance, and you feel unclear about interest rates, then this is the blog for you. Read on to gain a better understanding and be sure to contact the experts at Local Mortgage with any questions that you have.

The Basics of Interest Rates

Before discussing what makes a specific interest rate better than another rate, we should first clarify what exactly interest rates are, and discuss the function they perform. Hopefully, this will make the following discussion of interest rates easier to comprehend.

You can think of interest rates as a price you pay for risk. In the case of loans specifically, interest rates can be thought of as the price you pay the lender for taking on the risk of letting you borrow their money. The riskier the loan, the higher the interest rate the lender needs as payment for them giving a loan.

From the lender’s perspective, interest rates serve as the return they receive from an investment. When someone lends you money, whether it be for a business venture, a purchase (like a house or a car), or for something else, they are essentially investing in you. Instead of simply giving you money, they let you borrow money with the guarantee that they will get it and a little bit more back in the future. This is why interest rates can be thought of as the price on risk. If it is risky to lend someone money (because there is a good chance they may not give it back), then the lender will want to collect more from their initial investment to counter balance that risk. Therefore, they charge a higher interest rate.

In the case of mortgages, interest rates are typically lower than the rates for similar-sized loans would be. That is because mortgages are loans that have a major asset backing them, namely the house being purchased. This makes mortgages less risky than other loans.

A Simple Example of Interest Rates

Perhaps a simplified example will show why this makes sense. Suppose you choose to invest 100,000 dollars in a business venture. What happens if that business venture fails soon after your investment? There is a good chance that you would simply be out 100,000 dollars or close to it (depending entirely on the details of the investment). Due to this possibility, you would be wise to charge a relatively high interest rate—perhaps 10 to 20%—to risk loaning your money to the business.

Now, suppose you instead loan the same 100,000 dollars to someone so that they can buy a house. What happens if they can’t pay you back? Well, you can still sell the house and collect money from the sale. In this case, you would not be out 100,000 dollars, and you may actually get most, if not all, of your money back. For that reason, you could charge a much lower interest rate—perhaps 4 to 10%—to take on the risk of loaning 100,000 dollars.

Remember, these are just simplified examples. They are not offers or any type of financial advice. The examples are meant to help you gain an intuitive understanding of interest rates and the function they serve in finances. If you would like to learn more about the basics of how interest rates work in the mortgage industry, then feel free to call our mortgage experts.

Start Your Mortgage Calculations With Local Mortgage

If you are looking to buy a house for the first time or you need to refinance, then contact Local Mortgage. Our team of experts is here to help you through the process and find the right mortgage rate for your needs. Remember to check our blog again, as we discuss what makes one interest rate better than another in our next post.