The FHA sets specific rules for their loans; however, they leave a large part of the decisions up to the lender. One of these decisions is the interest rates to charge. Each lender can charge its own interest rate. The rate you obtain depends on the market as well as your individual factors.
The Market is Only a Small Piece of the Puzzle
Lenders will watch the market and base the rates they offer on the market. This means rates can change daily or even more frequently. It’s not unusual to receive one quote in the morning and another in the late afternoon. Until you lock a rate in, you have no guarantee regarding what rate you will receive. You can choose when to lock your rate in; however, the longer you lock it in, the more you’ll pay for the lock.
You Control Your Interest Rates
What really determines your interest rates are your individual factors. Lenders look at your credit score, loan-to-value ratio, and debt ratio as determining factors.
Your credit score lets a lender know your risk level. The higher your credit score, the less risk you pose to a lender. The lower your credit score, the higher risk you pose. However, lenders don’t look at just your credit score alone. They also look at the credit history. Most lenders look back at least 2 years. They look for things like bankruptcies, foreclosures, and defaulted loans.
If you have a low credit score or shaky credit history, your interest rate may be higher. Lenders often have adjustments they make for risky borrowers. They make up for the risk by charging you more to borrow the money.
Your loan-to-value ratio also determines your risk level. The more money you borrow, the higher the risk the lender takes. While it’s true that FHA loans allow you to borrow up to 97.5% of the home’s value, you don’t have to borrow that much. You can put down as much as you want on the home. The less you borrow, the lower the interest rate a lender may charge you.
Finally, your debt ratio plays an important role in the interest rates lenders charge. The higher your debt ratio, the more risk you pose. FHA loans allow debt ratios of 31% on the front-end and 43% on the back-end. This doesn’t mean you should maximize your debt ratios, though. The less debt you have, the lower interest rate a lender may quote you.
Choosing the Right Interest Rates
Contrary to popular belief, interest rates aren’t the only factor you should consider. For example, you may receive a quote for a 3% rate on a 3/1 adjustable rate mortgage and a 4% rate on a fixed rate loan. Your instinct may be to grab the 3% rate. However, the 3/1 ARM adjusts after three years. That 3% rate could be significantly higher after that point as the loan can adjust on a yearly basis. The 4% fixed rate will remain 4% for the life of the loan or until you refinance.
Even if you receive two quotes for the same term, you still must consider the closing costs. These play a large role in your loan. One way to determine the best rate is to look at the APR. This lets you know the effective interest rate you pay over the life of the loan. This takes into account the closing costs you pay. Over the life of the loan, you probably want to pay the least amount possible. Focusing on the APR can make that happen.
The bottom line is that the FHA does not make or control interest rates on their loans. It’s an agreement between you and a lender. You don’t have to take the first rate a lender quotes you. It’s possible to negotiate the rates. If a lender won’t negotiate, you can also shop around with different lenders. Considering at least three quotes can help you find the best loan for your needs.