Wondering what determines your mortgage rate? Your mortgage interest rate is based on a combination of personal financial factors and market conditions. Some factors like inflation and the economy are outside your control. Others, including your credit score, down payment, debt-to-income ratio, type of property and loan type, can directly impact the rate you receive. Understanding how mortgage rates are determined can help you prepare financially and position yourself to qualify for the most competitive rate possible.

What Determines Mortgage Rates?

Mortgage rates aren't determined by a single factor. Instead, lenders evaluate your financial profile, the property you're financing and current market conditions to determine the interest rate you're offered. The primary factors that affect mortgage rates include:

• Credit score
• Down payment and loan-to-value (LTV) ratio
• Debt-to-income (DTI) ratio
• Loan type and amount
• Loan term
• Property type and occupancy
• Market and economic conditions
• Federal Reserve Policy

Let's take a closer look at each one.

Factors You Can Control

1. Credit Score

Your credit score is one of the most important factors lenders consider when determining your mortgage rate. It's a three-digit number that tells a lender how likely you are to pay your credit obligations and is based on financial factors, including how much debt you owe, how much credit is available to you and your history of debt payment. A higher credit score demonstrates a history of responsible borrowing and may help you qualify for a lower interest rate.

Improving your credit score by even 20 to 40 points before applying for a mortgage could make a meaningful difference in the rate you're offered.

Tips to improve your credit score:

• Pay bills on time.
• Reduce outstanding credit card balances.
• Avoid opening new credit accounts before applying.
• Review your credit report for errors and dispute inaccuracies if necessary.

2. Down Payment & Loan-to-Value (LTV) Ratio

A down payment is the portion of the home purchase price you will pay upfront. The amount you put down directly affects your loan amount, whether you'll need private mortgage insurance (PMI) and the mortgage interest rate you may qualify for.

A larger down payment reduces your loan-to-value (LTV) ratio, which compares the amount you borrow to your home's appraised value.

For example:

• Home price: $300,000
• Down payment: $60,000
• Mortgage: $240,000
• LTV: 80%

In general, an LTV above 80% means you're financing a larger percentage of the home's value, which may result in a higher mortgage interest rate. An LTV of 80% or below often qualifies borrowers for more competitive rates.

If you're unable to put 20% down, don't assume homeownership is out of reach. Many loan programs allow qualified buyers to purchase a home with a smaller down payment.

3. Debt-to-Income (DTI) Ratio

Your debt-to-income (DTI) ratio measures how much of your gross monthly income (before taxes and deductions) goes toward monthly debt payments. Lenders use this calculation to determine whether you'll be able to comfortably manage a new mortgage payment along with your existing financial obligations.

To calculate your DTI, divide your total monthly debt payments by your gross monthly income. While many loan programs have different DTI requirements, a lower DTI generally improves your chances of qualifying for both a mortgage and a more competitive interest rate.

In general, many lenders prefer a DTI of 43% or lower, although acceptable limits vary depending on the loan program and borrower qualifications.

Ways to improve your DTI include:

• Paying down existing debt
• Increasing your income
• Avoiding new loans before buying a home

4. Loan Type and Amount

The type of mortgage you choose and the amount you borrow can both affect your mortgage interest rate.

Different loan programs including conventional, FHA and VA loans have unique eligibility requirements, fees and pricing. Depending on your financial situation, one loan type may offer a more competitive interest rate than another.

The amount you borrow can also affect your mortgage interest rate. Depending on the loan amount, your mortgage may be classified as either a conforming loan or a jumbo loan.

Conforming loans fall within loan limits established each year and often have different pricing than jumbo loans, which exceed those limits. Because jumbo loans typically involve larger borrowing amounts, they may have different qualification requirements and interest rates.

Your lender can help you determine which loan category applies to your situation and how it may affect your mortgage rate.

5. Loan Term

The length of your mortgage, also known as loan term, affects both your interest rate and monthly payment.

Common loan terms include:

• 30-year fixed mortgage
• 15-year fixed mortgage

Some borrowers may also choose an adjustable-rate mortgage (ARM), which has an interest rate that can change over time based on market conditions.

Shorter loan terms often have lower interest rates because the lender assumes less long-term risk. However, they typically come with higher monthly payments.

Longer loan terms generally offer lower monthly payments but may result in paying more interest over the life of the loan.

A mortgage calculator can help you compare different loan terms and interest rates to estimate your monthly payment and the total cost of your home loan.

6. Property Type and Occupancy

The type of property you buy and how you plan to use it can both affect your mortgage interest rate. Lenders evaluate these factors because different properties and occupancy types present different levels of risk. Generally, the lower the perceived risk, the more competitive the mortgage rate.

Property Type

• Single family home (1 unit): Single-family homes are typically considered the lowest-risk option because they're generally easier to sell if a borrower defaults. As a result, they often qualify for the most competitive mortgage rates.
• Condominiums: Condo loans may carry slightly higher interest rates than single-family homes. Lenders evaluate factors such as the financial health of the homeowners association (HOA), owner-occupancy levels, and the overall stability of the condominium project when determining risk.
• Multi-Unit Properties (2 to 4 units): These properties typically have a higher interest rate, because lenders tend to see them as semi-investment properties, since one or all units will be rented. Also, these type of properties carry higher maintenance costs and higher tenant turnover risk.

Occupancy Type

How you plan to use the property also influences your mortgage rate. The three primary occupancy types are:

• Primary residence: The home where you live most of the year. Because borrowers are generally more likely to prioritize payments on their primary home, these loans often qualify for the lowest mortgage rates.
• Second home: A property you occupy part of the year, such as a vacation home. These loans typically carry slightly higher interest rates than primary residences.
• Investment property: A home purchased primarily to generate rental income or for future resale. Because investment properties present a higher level of risk to lenders, they usually have the highest mortgage interest rates of the three occupancy types.

Factors You Can't Control

7. Market and Economic Conditions

Not all factors that affect mortgage rates are within your control. Mortgage rates are also influenced by the overall economy and financial markets.

Some of the biggest factors include:

• Inflation: When inflation is high, mortgage rates often rise to help offset the declining purchasing power of money.
• The economy: A strong economy can increase demand for borrowing, which may put upward pressure on interest rates.
• Financial markets: Mortgage rates are affected by broader market trends that influence the cost of borrowing.

While you can't control these economic factors, understanding how they affect mortgage rates can help you make informed decisions about when to buy a home or lock in your interest rate.

8. Federal Reserve Policy

A common misconception is that the Federal Reserve directly sets mortgage interest rates. It does not.

Instead, the Federal Reserve sets the federal funds rate, which influences interest rates throughout the economy. While changes to the federal funds rate can affect mortgage rates, the relationship isn't direct.

That's why mortgage rates don't always move in the same direction as the federal funds rate. Even when the Federal Reserve leaves the federal funds rate unchanged, mortgage rates may still rise or fall based on economic conditions.

The Bottom Line

While some factors that determine your mortgage rate such as inflation and economic conditions are outside your control, many others are not. Improving your credit score, saving for a larger down payment, reducing your debt-to-income ratio and choosing the right loan can all help you qualify for a more competitive mortgage rate.

Before buying a home, take time to strengthen your financial profile, compare loan options and understand how different mortgage terms may affect your monthly payment and long-term borrowing costs. Even a small difference in your interest rate can result in significant savings over the life of your loan.

If you're ready to explore your financing options, an FNBO Mortgage Loan Officer can help you compare loan programs and find a mortgage that fits your financial goals.

About the Author
Mireya Luna currently serves as a Community Mortgage Lender at FNBO. In her role, she works closely with families to achieve financial stability and long-term economic success through homeownership. She is also an Adjunct Professor at Aurora University. Mireya holds a Bachelor's degree in Spanish Language and Literature from Northern Illinois University and a Master of Public Administration from Baruch College.