How mortgage rates are calculated in the USA: What you need to know

To secure the best deal for your financial situation, it is important to understand how mortgage rates are calculated

How mortgage rates are calculated in the USA: What you need to know

To understand how mortgage rates are calculated, it is important to know that some factors are within your control, and some are not.

Your credit score, down payment, and loan term are examples of factors that are within your control. The Federal Reserve’s monetary policy and inflation are not in your control.

When securing the best rate for you, it is important to understand not only these different factors, but also how to negotiate more favorable mortgage rates for your financial situation. In this article, we will explore how mortgage rates are calculated.

Here is everything you need to know.

How are mortgage interest rates calculated?

Mortgage lenders multiply your outstanding loan balance by your interest rate annually. This figure is divided by 12 since you make 12 monthly mortgage payments each year. For instance: if you owe $300,000 on your home loan and your mortgage interest rate is 4%, you will owe $1,000 in interest each month initially.

In this example, the formula for your mortgage interest rate would look like this:

$300,000 x 0.04 ÷ 12

The remainder of your mortgage payment is applied to your loan principal.

How mortgage rates are calculated: determining factors

Numerous factors help determine your mortgage interest rate, including personal factors such as your credit score, loan term, and down payment. However, there are factors beyond your personal finances that can impact your mortgage rate, including your lender’s business plans or economic uncertainty. These various factors can make it difficult to calculate your mortgage rate.

When determining your mortgage rate, mortgage lenders usually consider two major factors, which are:

  • How likely you are to pay off the home loan
  • What is happening in the financial markets/economy

Your ability to pay off the mortgage is based on how well you have managed your personal finances, such as savings, total debt, income, and credit score.

The second factor, which is largely out of your control, is influenced by the larger economy, the Federal Reserve’s monetary policy, and inflation. Because financial markets and the economy are always fluctuating, it is crucial that you keep your personal finances in the best possible position.

In the next section, we will look at what you can and cannot control when determining how mortgage rates are calculated.

How mortgage rates are calculated: what’s in your control

Mortgage lenders offer rates based on how likely it is you will be able to repay the borrowed money. Your history and financial information indicate that a large down payment and high credit score reduce the odds you will be unable to make your mortgage payments. Because of this, the lowest rates are often offered to the borrowers who pose lenders the least amount of risk.

Here is a look at the factors that are in your control when determining how mortgage rates are calculated:

  • Credit score
  • Down payment/LTV ratio
  • Occupancy
  • Loan term
  • Fixed-rate versus adjustable-rate
  • Loan purpose
  • Property type

Let’s take a closer look at each of the factors that determine how mortgage rates are calculated:

Credit score

For mortgage lenders, your credit score is a significant factor when determining how your mortgage rate is calculated. How you have paid your past credit accounts is a reliable indicator of how you will manage your home loan. To increase your credit score, you should ensure you pay your debt on time. You should also avoid opening multiple credit accounts at the same time and keep credit card debt balances low. Remember: your credit score should be 780 minimum to get the best rates on a conventional mortgage.

Down payment/LTV ratio

Your down payment is of particular importance if you take out a conventional loan. Putting more money down means it will be easier to quickly repay your loan balance should you sell your property later. And since that makes you less risky in the eyes of lenders, they will usually offer you lower rates.

If you are refinancing, you will have to consider your loan-to-value (LTV) ratio, which represents how much of your property’s value you are borrowing. For instance: if you are borrowing $300,000 on a property worth $375,000, your LTV ratio would be 80%. As a general rule, the lower your LTV ratio, the lower your mortgage interest rate will be.


Mortgage lenders use the term occupancy for how you plan to use your home. The most favorable rates go to borrowers who plan to live in the home as a primary residence. Compared to second homes or homes they plan to rent out, homeowners usually protect their investment in their primary residence. Lenders therefore charge higher mortgage rates for vacation homes and investment properties. This covers them in case you fail to make mortgage payments in a financial emergency.

Loan term
Loan term refers to the number of years it takes you to repay your home loan. A shorter loan term builds equity more quickly—and enables you to repay your lender more quickly. These are factors that lead to a better rate on 15-year mortgages compared to 30-year mortgages.

Fixed-rate versus adjustable-rate

Most mortgage lenders quote fixed-rate mortgages. When fixed rates are high, however, lenders might offer you an adjustable-rate mortgage (ARM). The ARM may also come with a lower teaser rate to save you money for the first three to 10 years of the term of the loan. Depending on the type of ARM you choose, your rate may increase after the initial low-rate period has ended.

Loan purpose

You must tell the mortgage lender the reason you are taking out a loan. If you are purchasing a property—especially as a first-time buyer—lenders might offer special rates or closing cost discounts. If you are refinancing your home loan to reduce your loan term or mortgage rate, you will get more favorable refinance rates. If you are applying for a conventional mortgage, tapping equity with a cash-out refinance often comes with a significantly higher rate.

Property type

Your home loan is secured by a home. Because of this, the type of property you purchase is yet another factor that can affect your mortgage rate. For instance, single-family homes are usually seen as the least risky for lenders if they have to foreclose and resell to get back their investment. The following property types often come with higher rates:

  • Multi-family homes (two-four units)
  • Condominiums
  • Manufactured homes

When determining how mortgage rates are calculated, property type matters.

When determining how mortgage rates are calculated, property type matters.

How mortgage rates are calculated: what’s out of your control

Homeowners are focused on the terms of their own home loans. Investors, meanwhile, view mortgages as fixed-income investments. In other words, when a lender fronts you with a lump sum, they expect to be paid interest over the life of the loan.  

The cost of money that lenders will give you depends on various factors, which include the following:

  • Economic reports/markets
  • Inflation
  • Federal Reserve monetary policy
  • Lender pricing models

Let’s take a closer look at each of the factors that determine how mortgage rates are calculated:

Economic reports/markets
Investors analyze numerous economic reports each month to detect strengths and weaknesses in the wider economy. The jobs report is critical since it provides traders with a look at job growth in the USA. Because it usually leads to inflation, a strong job market is typically bad news for interest rates.

Keeping an eye on the bond market is a good hint at the direction of interest rates. Mortgage rates often follow their lead if the yields are headed higher. If they decrease, mortgage rates will typically decrease also.


Inflation measures how much the costs of goods and services increase in a specific period. Inflation is usually seen in the form of increased house prices and higher costs for gas and groceries. Inflation is typically bad for mortgage interest rates. Why? It usually leads to increases in the federal funds rate, which is the target rate that banks use to lend money to one another.

Federal Reserve monetary policy

The central bank of the USA, the Federal Reserve, has a primary purpose to maintain economic stability by setting monetary policy. When inflation rises too quickly, goods and services become more expensive for both businesses and consumers. To combat inflation, the Fed increases the federal funds rate to settle the economy and reduce inflationary pressure. Mortgage lenders often pass those increases onto consumers through high mortgage rates.

Lender pricing models

Pricing models are set up by mortgage companies and are based on the number of home loans they want to originate and how much profit they want to make. A mortgage lender with a higher profit margin is more likely to offer you a higher mortgage rate. The lender might justify the higher rate based on a higher level of services.

Other mortgage lenders specialize in being price lenders. These lenders might offer significantly lower mortgage rates to high-credit-score borrowers with digital loan process. Mortgage lenders can adjust their model at any point. For this reason, you should shop with at least three lenders to find the best rate for you. Loan estimates from several different companies will help you determine the best fit.

Can mortgage rates be negotiated?

Yes, mortgage rates are negotiable most of the time. As a borrower, you can shop around and compare rates from different mortgage lenders. You can then use these as bargaining tools to negotiate for a lower mortgage rate from your preferred mortgage lender.

While it can be daunting to negotiate mortgage rates, it is a process that you can navigate strategically. Let’s look at some tips to negotiate mortgage rates more effectively:

  • Know your local market
  • Improve your credit score
  • Shop around
  • Consider a mortgage broker

Here is a closer look at each.

Know your local market

It is important to understand the current state of your local mortgage market before negotiations. You can do this by reviewing mortgage lenders’ websites regularly.

Financial news outlets are another good source. For benchmark rates, for example, you may want to consult the Freddie Mac Primary Mortgage Market Survey. Another invaluable tool is an online mortgage calculator. Knowledge in these areas will help you recognize the best offer when it comes along.

Improve your credit score

If you are considered low risk, mortgage lenders will be more inclined to negotiate with you. A strong credit score is therefore a good way to better your bargaining position.

Paying down your debts, avoiding late payments, and avoiding new credit lines are great strategies for improving your credit score. Remember: a high credit score of 750 minimum is more likely to secure a favorable mortgage rate than a credit score under 600.

Shop around

This is a tip that is worth repeating. Comparing mortgage rates from various mortgage lenders will help you secure the best rate, without even needing to negotiate. For example, one lender may offer a rate of 7.5%; another might offer a rate of 7.2%. Shopping around will help you find these differences and make a better decision.

Consider a mortgage broker

Mortgage brokers act as intermediaries between borrowers and prospective lenders. A major part of a mortgage broker’s job is to establish relationships with lenders, which comes in handy when it comes to negotiating. Brokers also know which mortgage lenders are more receptive to negotiating or offering deals that suit your financial situation.

To help you understand how mortgage rates are calculated, consider working with a mortgage broker.

To help you understand how mortgage rates are calculated, consider working with a mortgage broker.

How mortgage rates are calculated: closing thoughts

When shopping for the best mortgage rates, it will help to understand how mortgage rates are calculated. A part of this understanding will be knowing which factors are within your control and which are reliant on the wider economy. Improving your credit score and making a larger down payment, if possible, are two examples of factors that are within your control. The Federal Reserve’s monetary policy and inflations are out of your control.

Remember: the more knowledge you have, the better off you will be.

For help getting the best possible mortgage rate, get in touch with one of the mortgage professionals we highlight in our Best of Mortgage section. Here you will find the top performing mortgage professionals across the USA.

Did you find these tips useful? Do you have experience determining how mortgage rates are calculated? Let us know in the comment section below.