Mortgage Interest Rate Definitions

                 Mortgage Interest Rate Definitions

 

Mortgage interest expenses may cost you thousands of dollars a year.

As a consumer or investor, your mortgage interest expenses can increase your real estate costs by hundreds of thousands of dollars over the years. On the other side of the table, the bank collects interest payments to improve its bottom line. As a prospective homeowner, it is important to define how mortgage interest rates are calculated. From there you can devise an effective real estate strategy to establish wealth, while also guarding against foreclosure.

Identification

Your mortgage contract specifies terms for a loan that is to be backed by real estate. To protect its financial interests, the bank or other lending institution will rarely approve a loan principal amount that exceeds the initial appraised value of your home. The bank collects interest payments in exchange for making the mortgage loan.

Features

The bank charges mortgage rates according to risks. First, the bank will analyze the size and purpose for the mortgage. You can expect interest rates to increase for larger principal balances. Mortgage rates are also higher for investment properties. The bank feels that a resident-owner should be highly motivated to keep his mortgage current to avoid foreclosure and eviction. Alternatively, an investor may simply abandon a failing project and refuse to pay the mortgage due to a lack of rental income.

Considerations

During the mortgage underwriting process, the bank will review your personal finances to determine your ability to make timely payments. The bank will charge interest rates accordingly. Your credit report and FICO score are especially important. According to Bankrate.com, keeping a FICO score above 760 allows you to negotiate the lowest mortgage rates. To secure a competitive rate, you also want to apply for a mortgage loan and payment that fits within your budget. Generally, an affordable mortgage payment falls between 28 and 33 percent of your gross monthly income.

Types

Your mortgage may be classified as either a fixed-rate or adjustable-rate mortgage (ARM). A fixed-rate mortgage carries the same interest rate throughout its loan term, which may be 15 or 30 years. Alternatively, an adjustable-rate mortgage features variable rates that shift based on economic conditions. Most ARMs are pegged to a certain interest rate index, such as the 12-month London Interbank Offered Rate (LIBOR). For example, your monthly ARM rate may add a 5 percent premium to current LIBOR.

Warning

All mortgage products feature interest rate risks that can hurt your bottom line. As a conservative home buyer you may covet a fixed-rate mortgage to lock in a particular interest rate. If future interest rates fall, however, you may be stuck with a relatively expensive home loan. Conversely, Investopedia associates ARMs with payment shock caused by significant interest rate increases that translate into unaffordable mortgage payments. Remember, the foreclosure process begins after 30 days of missed payments.