Mortgage - Home Mortgage

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Home Mortgage Interest

Interest is perhaps the most important concept a person needs to learn to understand mortgages and how they work.

The way a mortgage works is actually quite simple, a person locates a piece of real estate they want to purchase. They then approach a lender who gives them the money they need to buy the land.

In exchange for the money the buyer signs an agreement in which they agree to pay the mortgage holder back along with interest. The interest is a small percentage of the principal of the mortgage. The interest is the mortgage holder’s profit and how they make money off the mortgage.

How Interest Rates Are Determined

The amount of the interest or interest rate is the price a homeowner pays for borrowing money in a mortgage. The interest rate is determined by a number of factors including inflation, the market and the risk the lender takes in making the mortgage.

Inflation; the rate at which money loses value, can cause mortgage interest rates to go up and down. When inflation is high, interest rates are higher, but when inflation is low interest rates are lower. This is why it’s important to lock in a low interest rate when you take out a mortgage. If inflation causes interest rates to rise in the future the amount of mortgage payments will increase.

The market and interest rates

The market determines the cost of interest. The banks that issue mortgages borrow the money they lend to you from the financial markets or the Federal Reserve. The rate these entities charge for their credit determines the rate the banks charge homeowners.

This is why those considering a mortgage should watch the interest rates published in newspapers and the internet. The best time to take out a mortgage is when interest rates are low. The worst time is when interest rates are high.

Home buyers should remember that in traditional mortgages interest rates are locked in for the life of the mortgage. The homeowner could end up paying a high interest rate for the full life of the mortgage.

Other factors in determining interest

The next factor mortgage issuers consider in determining the interest rate is the risk they take. Generally, the lower the risk to the mortgage issuer, the lower the interest rate to the homebuyer.

This is why homebuyers with bad credit scores often have to pay higher interest rates. Lenders believe that those with bad credit are more likely to default on the mortgage and face foreclosure.

It is also why longer term mortgages come with a higher interest rate. In a longer mortgage such as a 30 year mortgage there is more possibility of foreclosure so a higher interest rate is charged.

How to lower your interest rate

It is sometimes possible for mortgage holders to lower their interest rate through refinancing. Mortgage companies will often refinance, that is issue a new mortgage with a lower interest rate to a person whose credit record or income has changed.

Every homeowner should try and refinance their mortgage so their interest rate will be as low as possible. The lower the interest rate the less you will pay on the mortgage.