Homebuyers

Which Home Loans Offer the Lowest Interest Rates?

If you’ve shopped around for a home loan, you’ve may have noticed that interest rates are not one-size-fits-all. There are a number of factors that impact the interest rate you may be eligible to receive.

Rates often vary depending on what type of loan you choose. The length of the loan may also affect the rate, as will the size of the down payment, and other considerations. Those with higher credit scores, less debt, and larger down payments may also be able to snag a lower rate.

“You can’t look at these things in a vacuum,” said Stephen Moye, a New American Funding sales manager based in San Diego.

Importantly for buyers, small differences in rates can have a big impact. Even small changes have the potential to increase or decrease your monthly payment. This can add or subtract potentially tens of thousands of dollars over the life of a 30-year loan.

So, why is the spread in rates different for different types of loans, even for the same borrower? Often, it comes down to the loan’s structure and how much uncertainty the lender takes on.

Basically, an interest rate is the lender pricing the amount of risk that it’s taking on by lending out the money. A higher interest rate indicates a higher risk. A lower rate means a lower risk.

And the amount of risk varies depending on the factors mentioned above, plus many more. With that in mind, let’s look at these factors and how they impact interest rates.

Why are mortgage rates for buying a home often lower than for refinancing a home? 

Mortgage interest rates for refinancing an existing loan tend to be a little higher than rates for a purchase loan used to buy a home. That’s because of how lenders view the risk involved.

Lenders tend to see borrowers who are purchasing as more motivated to close and keep up with payments. This can sometimes translate into slightly better pricing via a lower interest rate.

In contrast, a refinance is often about a homeowner saving money or tapping into home equity. While that’s a financially savvy move for homeowners, refinance rates can be higher to offset the risk to lenders since the homeowner could end up with less equity in the home than they had before.

Are rates lower for adjustable-rate mortgages than for fixed-rate mortgages?

Adjustable-rate mortgages often offer lower interest rates at the beginning of the loan compared to fixed-rate mortgages.

A fixed-rate mortgage locks in your rate for the entire term, whether that’s 15 years or 30 years. With one of these loans, you’re protected from rising interest rates over the life of the loan. But your rate is often a little higher than adjustable-rate loans because you’re essentially trading the security of the same interest rate for 15 or 30 years for a slightly higher rate.

An adjustable-rate mortgage (ARM) typically offers a lower initial rate at the beginning of your loan term, usually fixed for the first five, seven, or 10 years. However, after that period ends, the rate adjusts based on current rates up to a certain amount. The potential drawback is that your rate (and therefore monthly payment) can rise down the line.

For some buyers, particularly those who plan to sell or refinance before the rate adjusts, an ARM may be the cheaper option.

FHA, VA, and USDA Loans:  Which one has the lowest interest rates?

Government-backed loans, such as Federal Housing Administration (FHA) loans, U.S. Department of Veterans Affairs (VA) loans, and U.S. Department of Agriculture (USDA) loans, typically have lower interest rates than Conventional loans. This may save borrowers considerable money over the life of their mortgages.

Rates are lower for these loans because the government guarantees them. So, there is less risk to the lender if the borrower is unable to continue making their housing payments.

FHA loans are popular among first-time buyers and those with lower credit scores and more debt. One big perk is borrowers may be able to put just 3.5% of the sale price down on the home. However, they will be on the hook for mortgage insurance if they put down less than 20%.

Buyers who use a VA loan often don’t have to make a down payment or pay mortgage insurance for not doing so. These loans are reserved for veterans, servicemembers, and spouses in certain circumstances.

USDA loans also don’t require a down payment. However, buyers will need to pay mortgage insurance on these loans if they don’t put at least 20% down. These loans are also only available for eligible properties in rural and more suburban areas outside of cities.

The interest rate for each of these loans will vary, so be sure to discuss your options with a loan officer. They can help you determine which of these loans (or another type of loan) is the right choice for you.

Do HELOCs, cash-out refinances, or second mortgages offer the lowest interest rates?

Interest rates for home equity loans are typically higher than mortgage rates for buying a home or refinancing an existing home loan. These loans tap into a homeowner’s equity in their property. However, they generally have lower rates than most personal loans or credit cards

Home Equity Lines of Credit (HELOCs) work like a line of credit you can draw from as needed, typically with a variable rate. You can use as much as you need, up to a limit, during the draw period, typically five to seven years. Then you pay the interest on what you withdrew over the 10- to 20-year repayment period.

A cash-out refinance is another way to use your home equity. It replaces your old mortgage with a new, larger one. You pocket the difference, paying it back through your monthly mortgage payments.

It may have a lower rate than a HELOC, but rates are still typically higher than for a “rate-and-term” refinance. A rate-and-term is when you refinance without converting equity to cash. In this type of refinance, you are changing the interest rate you receive and the loan length. These are typically done when interest rates fall and homeowners want a new loan with a lower rate.

In a cash-out refinance, you’re taking on a larger loan balance in order to access the home equity and use that cash for whatever you like.

These rates are higher to accommodate the additional risk.

Then there’s the second mortgage, also called a home equity loan. These are fixed loans that allow the homeowner to access their equity without touching their existing loan or interest rate.

If something goes wrong and the borrower is unable to pay their mortgage, these loans are repaid only after the first loan is satisfied. That means the lender only gets its money back after the primary mortgage is repaid.

Stephen Moye NMLS# 268619