What Determines Your Mortgage Interest Rate?

The term mortgage is another name for a home loan. Banks and mortgage lenders have different loan programs; each with varying rates and terms. Rates signify how much the borrower has to pay, and the term denotes the length of the loan payback period. How interest rates are determined often seems like a mystery. Here we will demystify how interest rates are calculated.

Federal Funds Rate

As with many of the factors that go into the setting of mortgage rates, the Federal Funds Rate (FFR) is something that most homeowners are unfamiliar with. The Federal Funds Rate is the rate that bang institutions charge other institutions for borrowing funds overnight. Banks actually borrow from other banks to maintain their minimum reserve requirement set by the Federal Reserve (also called the Fed).

Federal Discount Rate

The Federal Discount Rate is the rate that the Federal Reserve charges banking institutions to borrow directly from the Fed. The funds borrowed are also used to maintain the reserve requirement as previously mentioned.

Risk Factors

Banks and mortgage lenders have different programs (also called products) that feature rates that are based on a variety of risk factors. People with good credit are seen as lower risk, so they get the best rate. The Prime Rate is the rate that banks charge their customers with the highest credit scores. The Prime Rate is usually 2.5 to 3 percent above the Federal Funds Rate.

The loans offered to with Prime Rates are referred to as conventional loans.  Unconventional loans (also called sub-prime) programs are offered to customers with credit scores that fall below the rate designated for customers with higher rates.

Loan Programs

There are also specialty mortgage programs that lenders offer. Other than conventional and unconventional, there are also programs specifically designed for veterans—under the Veterans Administration (VA), first-time homebuyers—under the Federal Housing Administration (FHA), and rural farmers—under the US Department of Agriculture (USDA). Rates can differ significantly, once the discounts from these government programs are applied.

Down Payment

The amount of your down payment is also a determining factor in dictating mortgage interest rates. A more substantial down payment will typically result in a lower interest rate. If the amount of the down payment is greater than 20 percent, that will positively affect the rate. Real estate agents can give more details about this process. A local real estate expert can help if you are in North Carolina and looking for Cary houses for sale.


As you can see, there are plenty of factors involved in the process of determining the mortgage rate charged by banks and mortgage lenders. Some elements are obviously beyond the control of the customer, but much can be done to secure a better rate. The main thing any homebuyer wants to do is lower the risk-factors in their personal situation. This is done by establishing strong credit, and being known as a borrower that is prompt with payments.

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