Why your mortgage rate is probably different from the ‘average’

While average rates in the 2%-3% range that homebuyers secured over the past few years are not coming back any time soon, mortgage rates also aren’t expected to rival the sky-high rates of the 1980s, which surged to almost 19% amid inflation.

But your rate may vary from the published average weekly rates. Here’s what goes into determining it.

Lower risk, lower rate

Your mortgage rate is based on a calculation the lender makes on how likely you are, as a borrower, to pay them back. It’s an approach called “risk-based pricing” that determines how much you’ll have to pay the lender for the loan.

The lower risk you present, the lower your mortgage rate will be.

Among some fairly well-known positive attributes:

• Your credit score. Usually this is your FICO score, but there are other kinds, like a Vantage score used by the credit reporting companies. The higher it is, the better your rate will be. Mortgage borrowers who are “super prime” or very good, have FICO scores over 720, according to the Consumer Financial Protection Bureau. The next level down are “prime” borrowers with scores between 660 and 719, followed by “near prime” at 620 to 659. A score under 619 is considered “sub-prime,” or “deep sub-prime” if the score is under 580. These categories will vary by lender.
• Your proportion of debts relative to your income. This is also known as your debt-to-income ratio. The lower that ratio is, the better for you. Generally, if it is 35% or less, you’re in good shape. On the other hand, if it is 50% or more, lenders are likely to limit your borrowing options.
• A strong employment history. Stable employment translates to being a safer borrower in the eyes of a lender.
• A strong track record of paying your debts. Typically, these are debts on a credit report, like student or personal loans, credit cards or auto loans. Paying your rent on time isn’t usually captured in a traditional credit score, but having proof of consistent on-time payments may help to lower your rate.
• A co-signer to the loan. A co-signer with good credit will lower your risk profile.

How much of a down payment you can make

This is one of the biggest determinants to lowering your mortgage rate. Borrowers who are able pay 20% of a mortgage — also known as a mortgage with a loan-to-value of 80% — are considered to be lower-risk borrowers because they immediately have more skin in the game.

Borrowers whose down payment is less than 20% are likely to pay a higher rate.

The applications examined by Freddie Mac to determine its average weekly mortgage rate are limited to conforming loans with a 20% down payment, so they are automatically going to be lower rates than a wider population of borrowers who put down less.

Between July 2021 and June 2022, the typical down payment for a first-time homebuyer was 6%, according to the National Association of Realtors. The typical down payment for a repeat buyer, likely using equity from a home sold, was higher, at 17%.

Red flags in your credit report

If any of the other measures mentioned above are deemed to be weak, the mortgage applicant can expect to pay a higher rate.

Also, as borrowers move down in FICO scores, those considered “sub-prime” by the industry — often due to having limited (or no) credit history — are viewed as more risky and can expect to be charged a higher mortgage rate if they are approved to borrow at all.

A recent analysis of mortgages from 2022 showed that mortgage application denials increased over the past year, largely because of insufficient income.

Younger buyers may have too short of an employment history, or work history that is too uneven, to qualify for lower rates.

Lowering your rate

You don’t have to settle for the first offer you receive. If you think you can do better, shop around and get quotes from a variety of lenders like a bank, a credit union or an online lender.

Another way people who are quoted a certain mortgage rate can lower it is by buying down the rate with discount points. This is akin to prepaying your interest.

Typically, each point is equal to 1% of the borrower’s mortgage cost. Paying 1 point brings the rate down by about 0.25%. A borrower with a $400,000 loan can buy down a 7.5% mortgage rate to 7.25% for $4,000.

By reducing the mortgage rate upfront, the monthly costs will be smaller for the life of the loan.

Also, while it doesn’t necessarily reduce your interest rate, putting more money down will reduce the overall size of your loan and that can reduce your monthly payments.

Know what is expected of a lender

Among the attributes that a lender is prohibited from taking into consideration to determine a borrower’s risk are race, color, religion, national origin, sex, marital status, age and any other category that is protected by the Equal Credit Opportunity Act.

The law also prohibits creditors from discriminating against credit applicants who’ve received income from a public assistance program, or because an applicant has exercised any right under the Consumer Credit Protection Act.

Beyond that, there are some added protections for consumers that are intended to provide transparency about a lender’s credit decisions, due to the 2011 Fair Credit Reporting Act.

According to the law, the Risk-Based Pricing Rule requires lenders to notify consumers if they are getting worse terms based on information in their credit report. Companies and lenders do this in various ways. Many provide disclosures to all customers that decisions based on a person’s credit report impact the terms and rate offered.

In addition, if a lender denies a loan application based on information in a consumer report, the lender must provide an “adverse action” notice to the consumer to explain the reason for the denial.

A borrower can then know what area of their financial profile that needs improvement, so they might be approved the next time.

Related: Mortgage rates hitting a 20-year high could snowball Utah’s housing crisis