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Mortgage rates: the basics

A mortgage rate is the interest charged on a mortgage. Lenders set mortgage rates, and rates can be fixed or variable depending on the type of loan. Mortgage rates change over time, and your credit score significantly impacts the rate you receive.

APR vs. interest rate

The interest rate is the percentage you pay over time based on the principal loan amount. The annual percentage rate 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.

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 that keeps the same interest rate throughout the loan term. Terms for fixed-rate mortgages typically range from 10 to 30 years. This type of mortgage is 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 periodically throughout the loan term. It typically starts with a fixed rate for a period of time, after which it switches to a variable rate. Once an adjustment period starts, the interest rate can increase or decrease according to current market rates.

An ARM’s interest rate usually depends on an index or benchmark. The specific benchmark or index depends on the type of loan, but in most cases, it’s aligned to the federal funds rate or the London Interbank Offered Rate (LIBOR).

What factors impact mortgage rates?

Mortgage rates are determined according to external and individual factors.

External factors

Economic conditions, like inflation levels and the current unemployment rate, influence mortgage rates and Federal Reserve policy decisions.

“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 loan originator at Calque, a lending partner. “The interest rate for mortgage lenders is directly influenced by the Federal Reserve’s actions and forecasts.”

Individual factors

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

Your credit score

Lenders use credit scores to determine a borrower’s likelihood of paying back a loan. If you have a higher credit score, you’re more likely to receive a lower interest rate. If you have a lower credit score, your interest rate will be higher.

Total home loan amount

The amount you borrow is generally the home price minus the closing costs and down payment, though closing costs may be included in the mortgage loan.

Home location

Most lenders take your state or home location into consideration before deciding on your interest rate. If you’re interested in getting a rough idea of your potential rates, get quotes from multiple lenders in your area.

Interest rate type

Mortgage rates can be adjustable or fixed. Fixed interest rates don’t change throughout the loan repayment period, while adjustable rates change with the market.

Loan type

Rates also depend on the type of mortgage loan you choose. There are conventional loans, government-issued loans, jumbo loans and more. Conventional loans are typically issued by private mortgage lenders, while government-backed loans are typically sponsored by the Federal Housing Administration (FHA), U.S. Department of Agriculture (USDA) or U.S. Department of Veterans Affairs (VA). Jumbo loans refer to loans that exceed maximum loan amounts set by the government.

Each type of mortgage loan 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 amount of time you have to repay the loan. Terms typically range from 10 to 30 years. If you choose a shorter term, like 10 or 15 years, the interest rate is likely to be lower, though you’ll also typically have higher monthly payments.

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

How to get a lower mortgage rate

You can lower your interest rate by paying a lender mortgage discount points.

“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,” Jim Black said. “A buydown can be any amount from [1% to 3%] in the cost of the loan amount.”

Buying discount points means you'll have a lower monthly payment.

Each discount point costs 1% of your loan amount. For example, for a $200,000 mortgage, one discount point would cost $2,000.

Black said the most important thing to consider when deciding whether 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.

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

Bottom line

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

Contact multiple lenders to find out what your loan options are and the rates you may 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.