Home Loan Interest Rates - 5 Things Every Borrower Should Know

Continuing our blog series of house buying tips, I'd like to explain a few key concepts about interest rates as they apply to home mortgage loans.

If you plan to buy a house in the near future, then the topic of home loan interest rates will be near and dear to your heart. That's because the interest rate you get on your home loan will play a role in how much money you pay each month.

With that being said, there are some common misconceptions about home loan interest rates and general points of confusion. This is especially the case for first-time home buyers. So in this installment of the house buying tips series, I'll talk about how an interest rate gets applied to a home loan, and how it affects you as the buyer / borrower.

• The interest rate offered by a mortgage lender will vary from one borrower to the next. So when you see a low interest rate advertised with an asterisk beside it, you can look at the asterisk as a way of saying "rates will vary." This brings us to the next important topic...
• The home loan interest rate you are offered will be largely determined by your credit score. The higher your score, the lower the rate you'll receive. On the contrary, a lower credit score means you'll end up paying a much higher interest rate on the loan.
• With an adjustable mortgage loan (ARM), your interest rate will start out low for a certain period of time, typically three to five years. After that, the rate will increase -- and often significantly. You have no way of knowing how much the rate will increase. The initial low rate is sometimes referred to as a "teaser rate" for this reason.
• Home buyers who plan to stay in a house for more than a few years benefit from the long-term stability of the fixed-rate mortgage. With this type of home loan the interest rate stays the same, regardless of what the economy does.
  
• Interest is one of several components that make up your monthly payment. These components are collectively known as PITI. The 'P' stands for the principal amount you are borrowing. The first 'I' is for the interest rate you are given by the lender. The 'T' stands for taxes on the property (that are often rolled into the loan). And the second 'I' stands for insurance you are required to have on the home.
• Today, you need a higher credit score to obtain the best interest rates. This article explains why. It has a lot to do with the mortgage crisis of 2007 - 2008 and the federal restrictions placed on lenders in response to that crisis.
  

Do you feel like you know more about home loan interest rates now? If so, I've accomplished my goal with this blog post. I recommend you follow each of the hyperlinks above and read the background information they provide. When you find links in those articles, follow them as well. By spending some time on this website (and similar educational websites), you'll increase your knowledge of home loans in general and interest rates in particular. And being an educated consumer is the first step to success.

Related article worth reading:
Current Mortgage Rates and What They Mean

Tips on Buying a House - Revisited for 2008

Lately, I've been updating many of the articles on the main website to reflect economic changes of the last year, changes in the housing market, etc. When updating the many house buying tips spread throughout the website, I find myself repeating a couple of points over and over. They have to do with buying a house in the new economy, and they are important points for first-time home buyers to understand.

So I thought I would update the blog with these points as well. In fact, I'm going to start a series of blog posts with house buying tips for the modern economy. Without further ado, let's dive into the first topic...

House Buying Tip #1 - Maintain a Good Credit Score

Good credit has always been important when buying a home and applying for a mortgage loan. But it's more important than ever as a result of the mortgage crisis we have experienced. Lenders today will require you to have a better score than in the past, and they will only offer you the best rates on your loan if you have a score of about 750 or higher.

This comes as a result of the tougher restrictions put upon mortgage lenders by the federal government. Here's what it means to you, as a future home buyer. If you want to (A) get qualified for a loan when buying a house and (B) get a good rate on that loan, you need to have a very good credit score. Otherwise, you'll have trouble qualifying for the loan. And if you do qualify for a loan with a bad score, you'll likely end up with an incredibly high interest rate on top of it. This means a bigger mortgage payment each month.

So in this house buying tip I'll offer some ways to improve your credit score (if necessary) and to maintain it into the future.

For starters, you need to find out what your score is in the first place. You can find some tools on the Credit Information section of our website to help with that, as well as the home buying tools page. If you obtain your score and find out that it's low, you need to focus on improving it before buying a house and applying for a mortgage.

Let me say that again ... it's important to boost your credit score before seeking a loan. You'll have an easier time getting qualified, and you'll get a better rate on the loan. This is one of the most important house buying tips you can take away from this article, which is why I keep repeating myself on this subject.

Elsewhere on this website, you can find plenty of tips for boosting your credit and related topics, so I wont go into it much here. I will say, however, that one of the quickest ways to improve your credit score before buying a house is to pay down your credit card balances and pay all future bills on time. These two things in concert can help you boost your score faster than just about anything else. You should also work on reducing your overall debt as well.

Like I said, this is the first house buying tip in a series that will focus on the modern economy, tougher lending standards and the like. If you found this tip helpful and want to stay in touch, bookmark this web address or subscribe to this blog's RSS feed.

More Tips in the House Buying Series

• Understanding the home loan interest rate

Using a Mortgage Loan Payment Calculator

It has always been important to buy within your means. But in light of recent economic events (and the current state of the economy), this is even more important. For anyone buying a home, a mortgage loan payment calculator can help with the all-important task of setting a budget.

But many people don't understand how mortgage payment calculators work, and that all of the numbers mean. So let's take a closer look at these helpful mortgage loan tools.

How a Loan Payment Calculator Works

Different calculators work in different ways. Some ask for more information up front, and therefore provide more accurate numbers upon calculation. While other mortgage calculators ask for less information and provide general "ballpark" numbers. But they all do essentially the same thing.

In most cases, a loan payment calculator will ask for certain pieces of information needed to estimate your monthly payment. This will include the loan amount, the interest rate, and the length or "term" of the loan. Most calculators default to current mortgage rates over a 30-year fixed-rate term, but you can easily adjust this to get a more accurate number.

Based on the information you provide, the loan payment calculator will tell you how much you could expect to pay each monthly (your mortgage payment). You can then judge how affordable a certain house might be, based on the amount you would have to pay each month.

The Credit & Interest Variable

Of course, there's one very important element that most mortgage loan payment tools don't take into account, and that's your credit score. The interest rate you receive from a lender will be largely based on your credit score. The better your score, the better the interest rate you will receive. This in turn will affect the amount of money you have to pay each month, because interest is a component of a mortgage payment.

Here's what to take away from this article. A payment calculator can help you determine your home-buying budget by breaking a loan amount down into monthly payments. But it's only a ballpark figure -- one that doesn't take your credit score into account. So while they are certainly useful, they are by no means the final word.

You can learn more about this subject or use our own mortgage loan calculator on this page.

FHA Home Loans and the Housing Recovery Act

You can't turn on the TV these days without seeing a news story about the U.S. economy in general and the housing market in particular.

Starting in 2007, we began to see record numbers of home foreclosures, a trend that continued into 2008 and shows no sign of slowing. But for many homeowners, help is on the horizon. And it comes in the form of FHA refinance loans.

Housing and Economic Recovery Act

The recently passed Housing and Economic Recovery Act of 2008 will help "at least 400,000 families" who are struggling with their mortgage payments and facing foreclosure. It will do this by providing FHA-insured refinance loans to switch the homeowners from high-interest ARM loans to fixed-rate mortgages with lower rates. For those accepted into the program, the end result will be a lower monthly payment and more desirable fixed rate that will no longer adjust / increase.

History of the FHA

The Federal Housing Administration was created in 1934, during the Great Depression, to make home financing available to a greater number of Americans. The FHA does not actually make home loans to consumers. Instead, they insure certain loans made by private lending institutions.

You've probably heard the term "government-backed financing" before. The FHA loan program is an example of this. By having government insurance in their favor, private lenders are more willing to offer mortgages to borrowers they normally wouldn't qualify (due to credit problems or other qualification issues). The lender is assured of getting their money back on the loan, even if the homeowner defaults and stops making payments. That's what the FHA insurance does.

The Refinancing Angle

Traditionally, the FHA loan program was focused on helping buyers in the purchase of a home. But as a result of the aforementioned Housing and Economic Recovery Act, the program is being opened up to homeowners who want to refinance. According to the HUD website, "an estimated 400,000 borrowers in danger of losing their homes will be able to refinance into more affordable government-insured mortgages." The program is slated to begin in October of 2008.

To find out if you are eligible, visit the HUD website or refer to this article. You have to go through an FHA-approved lender to apply for the FHA refinance loan. (Remember, the FHA does not actually offer the mortgage refinance loans. They only insure the loans made by private lenders.)

Getting Away from ARM Loans

The goal of this new program is two-fold. It is designed to help struggling homeowners who have adjustable-rate mortgages (ARMs) convert to fixed-rate mortgages. It's also designed to lower their mortgage rates in the process. While the ARM is not inherently evil -- and can even be a good thing if used wisely -- it has played a big role in the subprime mortgage crisis. This program is designed to give homeowners a way out of their ARM loans by refinancing to fixed-rate loans. At the same time, many people will lower their monthly interest rates. Lower rates and less uncertainty -- a double win.

What's the Catch?

Sadly, the federal government rarely passes legislation designed to help American citizens without putting something into it for their corporate friends. Such is the case here. We recently blogged about the status of Freddie Mac and Fannie Mae and how the government plans to bail them out. Well, the bailout is essentially written into this act as well. Pretty slick, huh?

One thing is certain -- our economy cannot handle foreclosures at the rate they've been happening lately. So the Housing and Economic Recovery Act could be a great thing. Only time will tell.

How to Buy a House With Bad Credit

If you are reading this blog post, I'll assume it's because you are researching how to buy a house with bad a credit score. You're in luck. Because I happen to have a secret formula for buying a home with bad credit.

In truth, I probably shouldn't be revealing this secret. Once the word gets out, the blog will be flooded with visitors, and my email inbox will burst at the seams. Oh well. I'm going to let the cat out of the bag anyway, consequences be damned. Here it goes.

How to buy a house with bad credit ...

Don't Do It!

There you have it. The best way to purchase a home with a bad credit score. Avoid it altogether. It's one of the worst things you could do in the current economy. Chances are, you won't even be able to pull it off. If you've been watching the news or following this blog recently, you'll know that buyers need higher credit scores today in order to quality for a mortgage loan.

Even if you get a loan with a bad credit score, you are going to pay a ridiculously high interest rate for the "privilege." Lenders will take full advantage of your inability to get a loan through most channels. So the one lender out of ten that actually offers you a loan will tack on an extremely high interest rate, which is going to jack up your mortgage payment even more.

This is the kind of scenario that leads to continued financial hardship down the road. It's why we have record numbers of home foreclosures right now. In the past -- before the mortgage meltdown and subsequent credit crunch -- it was a lot easier to buy a house with a bad credit score. In fact, there was an entire segment of lenders who catered to such buyers. But subprime lenders are now practically extinct, as well they should be.

There is one situation where it makes sense to buy a house with a bad credit score, and that's if you can pay for the home outright (without taking out a mortgage loan). In such rare cases, the credit score doesn't matter because the buyer can pay cash. On top of that, homeownership will help them improve their credit score, so it's a double win. But most people with bad credit are not in a position to buy a house out of pocket, so this scenario is rare.

In most scenarios, it's best for a person with bad credit to focus on improving his or her FICO score first ... before trying to buy a home. This statement has always been true, but it's even more applicable today in light of tougher lending standards.

Some people like to put a rosy, unrealistic spin on this topic. These people like to say that everyone should be able to buy a house regardless of their credit situation or financial status. My response to these people is, "Are you crazy?"

Sorry to be so blunt, but I'm a realist. And I think you deserve the truth. I think it's time to doff the rose-colored glasses and look at our economy in the harsh light of reality.

If you have bad credit there's no need to despair. You simply need to patient but persistent, and focus on improving your score first. Once you do that, you'll be in a much better position to buy a house. You'll have an easier time getting qualified. You'll have more loan options. You'll get a better rate on the loan. And you'll be less likely to become another foreclosure statistic.