You’ve probably heard that interest rates are at record lows right now, which means it’s a great time to buy a home if you’re in a position to do so. But it’s important to note that the interest rate you see listed online is the prime mortgage rate—it’s not necessarily the rate you’ll get if you secure a mortgage today.
The prime lending mortgage rate is the interest rate lenders offer their most creditworthy borrowers, meaning those they consider most likely to repay the loan. Each lender will have its own criteria for determining which credit scores are prime, but generally, scores of 620 and above are considered prime, while scores below 620 are subprime.
Banks typically determine their prime lending rates by looking at the federal funds rate and adding three percentage points to that number. For example, the current federal funds rate target range is 0-0.25 percent, so the prime rate would likely be between 3-3.25 percent.
In general, prime borrowers will get lower interest rates than subprime borrowers. Subprime borrowers are viewed as a higher risk, meaning there’s a higher chance they will default on the loan, so lenders charge higher rates to balance that risk. Many lenders don’t even offer subprime loans, so if you have low credit, you may have difficulty securing a mortgage.
Understanding how interest rates work can be confusing, and there are plenty of misconceptions out there. Here are seven things people commonly misunderstand about prime lending:
It’s understandable for someone to think the Federal Reserve sets prime rates because its actions do heavily influence interest rates. But technically, the Fed sets a target range that lenders base their prime rates off of. Earlier this year, the Fed slashed its target range to 0-0.25 percent (which is as low as it will go) due to the pandemic and associated recession. It works to lower rates when it wants to boost the economy.
When browsing interest rates, you should be looking at the annual percentage rate (APR), which takes into account not only the interest rate, but also points, mortgage insurance, and other fees, like origination and underwriting fees, that you will have to pay when you take out a mortgage.
Rates can change significantly, even throughout a given day, so it’s worth checking regularly in order to lock down the best possible rate.
Rates can vary significantly from lender to lender, so it’s always a good idea to shop around. A large bank, a mortgage broker, and a local loan officer could all offer you a slightly different interest rate on the same day.
However, it’s also important to note that you shouldn’t base your entire decision on who can give you the lowest interest rate. If you’re stuck between two lenders and the rates are very close, you should also take factors like customer service into account. A reliable and dedicated loan officer is worth their weight in gold because they can walk you through the process and quickly send out pre-approval letters for any house you’re interested in.
Sometimes, the bank where you have a checking account will offer a customer discount when you take out a mortgage with them, but that doesn’t mean they will give you the best rate. You should always shop around and get multiple quotes from various lenders.
If you’re applying for a mortgage with your spouse, the lender will typically pull both of your credit scores and use the lower of the two to determine your rate, so the least creditworthy person will have the most effect on the interest rate you receive.
Lenders use several factors when determining whether to approve your loan application, including your debt-to-income ratio, employment status, and overall financial situation. Even if you have great credit, you will need to check a few other boxes in order to secure a mortgage.
Mortgage interest rates are at record lows, which could save you a substantial amount of money over the lifetime of your home loan. If you’re considering buying a home, meet with a loan officer to talk about prime lending and lock in a low rate today.