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A guide to mortgage rates

A mortgage rate is the interest charged on a mortgage. It's typically set by lenders and can stay fixed or fluctuate depending on conditions in a mortgage agreement. Mortgage rates vary over time, and your credit score significantly impacts the rate you receive. Mortgage rates rise and fall by interest rate cycles, affecting the home market.

Whether you're a first-time buyer or an experienced homeowner looking to refinance, this guide will help you understand how to compare mortgage rates, get the lowest rate possible and more.

APR vs. interest rate

The interest rate is the percentage you pay over time based on the principal loan amount. The annual percentage rate (APR) is the figure that represents the interest and additional fees like private mortgage insurance (PMI) and loan origination fees. The APR is higher than the interest rate because it includes the additional costs.

What factors impact a mortgage rate?

“The Federal Reserve sets interest rates according to the strength of the economy and to combat the number one fear, inflation and pushing citizens out of being able to afford to live,” said Jim Black, mortgage broker and industry advisor at Calque. “The interest rate for mortgage lenders is directly influenced by the Federal Reserve’s actions and forecasts, which has made rates increase in lockstep with the Federal Reserve interest rates.”

While the Federal Reserve has a lot of influence on current rates, there are some factors that determine your individual mortgage rate. Those include the following:

• Your credit score: If you have a higher credit score, you are more likely to receive a lower interest rate. If you have a lower credit score, your interest rate will be higher. Lenders use credit scores to determine a borrower’s likelihood of paying back a loan.
• Total home loan amount: The amount you borrow is the price of the home minus the closing costs and down payment, in most cases. The closing costs may be included in the mortgage loan, however.
• Home location: Most lenders take the state or your home location into consideration before deciding on the interest rate. If you are interested in getting a rough idea of your potential rates, talk to multiple lenders in your area.
• Interest rate type: There are two basic types of mortgage rates: adjustable and fixed. Fixed interest rates do not change throughout the loan repayment period, while adjustable, or floating rates, change with the market.
• Loan type: Rates heavily depend on the type of mortgage loan you and your lender choose. Some broad categories of loan types are VA, USDA, conventional and FHA loans. Each type has different eligibility criteria and requirements. Mortgage lenders can help you determine which loans you’re eligible for and the best one for your situation.
• Loan term: The loan term is the time in which you have to repay the loan. If you choose a shorter term (like 10 or 15 years), the interest rate is likely to be lower, but this also means higher monthly payments.

» MORE: What credit score is needed to buy a house?

How to get a lower mortgage rate

“A way for a homeowner or borrower to optimize a lower interest rate is to do a buydown or payment upfront known as discount points, to have a longer-term lower interest cost and rate. A buydown can be any amount from 1-3 percent (points) in the cost of the loan amount,” said Black. He explains that the most important thing to consider when deciding to go with points is if the added cost is worth it. “The longer it takes to recover the cost versus benefit, the less of an advantage it is to do a buydown,” he said.

What is a discount point?

If you pay the lender mortgage discount points, it lowers your interest rate. Each discount point costs 1% of your loan amount. For example, for a $200,000 mortgage, one discount point would cost $2,000. Buying discount points means you'll have a lower monthly payment.

How much does one point lower your interest rate?

Usually, each discount point lowers the interest rate by 0.25%. You can buy more than one discount point. While 0.25% might not seem significant, it can add up to a sizable amount over the life of the loan.

Types of mortgage rates

There are two main types of mortgage rates: fixed and adjustable.

Fixed-rate mortgage

A fixed-rate mortgage refers to a loan with a constant interest rate throughout the loan term. This means that the interest rate is the same from the beginning until the mortgage is paid off. Terms for fixed-rate mortgages vary, ranging from 10 to 30 years. It's a popular choice for homebuyers because they know exactly how much they'll pay each month over the life of the loan.

Adjustable-rate mortgage

An adjustable-rate mortgage (ARM) is a mortgage with an interest rate that changes throughout the loan period. Only the initial interest rate is fixed in an adjustable-rate mortgage. After the completion of a specified period, the interest rate can increase, decrease or reset on a monthly or yearly basis.

The interest rate of an ARM usually depends on an index or benchmark. The benchmark or index depends on the type of loan, but, in most cases, it is aligned to the federal funds rate or the London Interbank Offered Rate (LIBOR). Adjustable-rate mortgages are also called floating mortgages or variable-rate mortgages.

» MORE: FHA loans vs. USDA loans: 6 key differences

Bottom line

Mortgage rates change over time, and the rate you qualify for depends on factors including your credit history, the size of the loan, where the property is located, your down payment amount, the loan term, whether the loan has a fixed or adjustable rate and the type of loan.

Contact multiple lenders to find out what your loan options are and the rates you qualify for. Keep in mind that the interest rate is different from the APR, which takes fees into account and tells you how much the loan actually costs per year.