Home Loan Interest Rate

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How is a Home Loan Interest Rate Determined?

When you are searching for a home loan, do you ever wonder why so many different home loan interest rates are advertised? The truth is that all lenders have individual methods to calculate how much interest they will charge on a loan.

What is a home loan interest rate?

A home loan interest rate is the rate that a mortgage lender or an equity loan lender will charge you for lending you the money. It is normally expressed in annual percentage terms, for example 4.9% APR.

How do lenders calculate a home loan interest rate?

In simple terms, three steps are taken.

Step 1 - Indexes

Lenders do not use the same indexes or indicators to determine the cost of the money they are willing to lend. Generally they will use one of three options:

  1. The predominant rate published by the Wall Street Journal based upon a survey of 30 banks.
  2. The treasury bill rate notes made by the government to pay for national debt.
  3. LIBOR London Interbank Offered Rates the average interest rate of deposits of U.S dollars in the London market.

Step 2 - Margin

Every company will apply different profit margins to their loans. These profit margins will also have to take into account the overheads the financial institution has such as staff and loan servicing costs.

For example if the Wall Street predominant rate was 3% and a home loan lender always charges 2% margin, the home loan interest rate published would be 5%. This is the rate that you will see advertised online, in newspapers, magazines and in branches of financial institutions.

Step 3 - Your personal circumstances

When you apply for a home loan, your personal circumstances will always be taken into consideration. The lender will determine by looking at your past financial performance, how much of a risk you they are taking by loaning you the money. If you have a lower credit score they may load the home loan interest rate and you could end up with a higher interest rate than advertised.