What Is a Mortgage Interest Rate?

Definition and Example of a Mortgage Interest Rate

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

Use this mortgage calculator to get a sense of what your monthly mortgage payment could end up being.

You'd pay 5% of your total loan balance in interest if you have a 5% mortgage interest rate. but your principal balance should be much less after 10 years of making payments.

How Does a Mortgage Interest Rate Work?

Mortgage interest rates can vacillate, depending on larger economic factors and investment activity. The secondary market also plays a role.

Fannie Mae and Freddie Mac bundle mortgage loans. They sell them to investors who are 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.

This chart illustrates how 30-year fixed-rate mortgage rates have changed since 2000.

Interest rates are simply cited and agreed-upon percentages. The amount of interest you will pay each month will decrease as you pay off the principal balance you borrowed and as that number also decreases. Your percentage interest rate applies to that remaining balance.

Mortgage Interest Rate vs. Annual Percentage Rate (APR)

Your annual percentage rate is a more complete picture of how much it costs you to borrow.

What It Means for the Market

Mortgage rates don’t directly impact home prices, but they do influence housing supply, and this plays a big role in pricing. Existing homeowners are less likely to list their properties and enter the market as mortgage rates rise. This reluctance creates a dearth of properties for sale, driving demand up, and prices along with it.

Homeowners are more comfortable selling their properties when rates are low, which sends inventory up. It turns the market in the buyer’s favor, giving them more options and more negotiating power, but that can depend on how much rates rise. 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 in order to stand out.

How to Get a Good Mortgage Interest Rate

Rates vary by lender, so it’s always important to shop around for the mortgage lender that's offering the best terms. Each lender has its own overhead and operating costs. It has to charge differently in order to make a profit based on these factors.

The rate you’re offered depends largely on your own financial situation as well. A lender will consider:

• Your credit score
• Your repayment history and any collections, bankruptcies, or other financial events
• Your income and employment history
• Your level of existing debt
• Your cash reserves and assets
• The size of your down payment
• Property location
• Loan type, term, and amount

The riskier you are as a borrower, and the more money you borrow, the higher your rate will be.

Make sure you’re comparing the full loan estimate, closing costs included, regardless of which option you choose. You want to be able to accurately see whose pricing is more affordable.

Do I Need to Pay a High Mortgage Interest Rate?

You can usually pay discount points to lower the interest rate you're offered. These points are essentially a form of prepaid interest. One point equals 1% of the total loan balance, and it lowers your interest rate for the life of your mortgage. The amount it lowers your rate depends on your individual lender and the market at the time.

This is often referred to as “buying down your rate.” Calculate your break-even point (the time it will take for you to recoup the costs of the points you purchased) to determine whether this is the right move for you. Will you be in the home long enough to make it worthwhile? The longer you plan to live there, the more paying discount points makes sense.

You can also negotiate your mortgage interest rate. It doesn't hurt to ask whether the lender can make a better offer. You could save a significant amount of money over the term of the loan.