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Understanding home loans and interest rates

March 23, 2018

Securing a home loan is probably one of the most stressful parts of buying a new home. To get the best loan possible, it’s important to know what factors affect interest rates — a fraction of an interest rate can translate into thousands of dollars less or more over the life of a loan.

“When rates increase by 1 percent, a buyer loses 10 percent in purchasing power,” said Michael Deery, a mortgage specialist and president of Citywide Financial Corp. Since December, interest rates have gone up three-quarters of a percent and are now in the 4.375 to 4.5 percent range for a conventional loan.

In actual numbers, Deery said, that means a buyer who could afford a $600,000 home in December can only afford a $555,000 home today.

That’s why it’s more important than ever to get the lowest interest rates possible.

The single biggest factor a homebuyer can control in getting lower interest rates is their personal credit score. A high credit score generally leads to a lower interest rate. For a conventional loan, that score should be 740 or higher. (A good credit score is above 700 and an excellent credit score is above 800.)

Credit rates should be checked once a year. If you’re planning on buying a home, a credit rate check should be one of the first things you do, so you will have time to fix any errors or improve your score, which may take some time. Paying down credit cards, if you have a high balance, is a good way to get started, Deery said.

The amount of a down payment will also affect interest rates: The higher the down payment, the lower the interest rate. Loans with a standard 20 percent down payment will have a lower interest rate, but that is often not an option in San Diego’s pricey home market, especially for first-time homebuyers. Mortgage plans that require borrowers to pay only 3 to 5 percent down are abundant, but those loans will then require private mortgage insurance (PMI). The insurance is either added to the cost of the monthly loan payment or absorbed in higher interest rates.

San Diego’s steep home prices also result in higher interest rates because of the amount of the loan. Higher loans come with higher interest rates. The standard — or conforming — national loan limit, set by the Federal Housing Finance Agency, is $453,100. High-cost areas, such as San Diego, have a limit of $649,750 for a single-family home. But that high-balance loan limit comes with higher interest rates, usually by an eighth or a quarter of a percent, Deery said.

Fannie Mae-backed loans are also higher for condos than for single-family homes if the down payment is less than 25 percent, he said.

Also consider the length of a loan. Shorter terms have lower interest rates, but the monthly payment will be higher because you’ll have less time to pay off the loan.

If you’re planning on staying in your home only for a short time, you might want to look at adjustable-rate loans instead of fixed-rate loans. Fixed-rate loans don’t change over the life of the loan. Adjustable rates often start out fixed for a few years and then fluctuate with the market. The initial interest rate is sometimes lower than in a fixed rate, so if you’re planning on selling your home after a few years, an adjustable rate could save you money.

For those who plan on staying in their home for a longer period, fixed rates are a safer option. “We’re moving into a higher interest market in the next few years,” Deery said.