Understanding mortgage rates can be frustrating. Maybe you’ve
been shopping around for the lowest mortgage rate and are wondering
why no one will quote you the rates you’ve seen advertised or read
about in the news.

Here are some of the major things that determine the mortgage
interest rate charged to individual consumers. Some may be obvious
to you, others probably less so.

Credit score

Most borrowers realize that their credit score is going to
affect the type of interest rate they can get. What few of them
know is exactly how much.

Most lenders group credit scores in brackets, with the top
brackets getting the best rates. The highest bracket is typically
for FICO credit scores of 740 or 760 and above, the second bracket
usually begins at 700 or 720, then on down to 680, 660, 640 and
620, the last being about as low as you can go and still obtain a
mortgage with most lenders.

Generally, interest rates increase by about 20 basis points each
time you go down a bracket. So if borrowers in the 760+ bracket are
paying an average of 3.75 percent for a 30-year loan, those in the
next bracket down will likely pay around 3.95 percent, though the
steps get bigger toward the lower part of the scale. The Fair Isaac
Corp., which created the FICO credit scoring system, provides a
table on its web site, www.myfico.com, showing what current average
interest rates are for different credit scores in various parts of
the country.

Region

Where you live affects your interest rate. Many people aren’t
aware of it, but mortgage rates vary from one part of the country
to another. There’s no hard and fast rule, but generally interest
rates are somewhat higher in areas with a higher cost of
living.

It’s not a huge difference – for customers with good credit,
about 10 to 15 basis points more (0.10-0.15 percentage points) if
you’re getting a mortgage in a high-cost state like California or
New York versus lower-cost areas like Kansas, Idaho or Louisiana,
according to the Fair Isaac Corp., creator of the FICO credit
scoring system. That’s about equal to an additional $10-$20 a month
on a $250,000 30-year loan.

Points

One of the reasons you may not be able to obtain the same
interest rates you read about or see advertised is that those rates
often include points. Points are a form of pre-paid interest that
can be used to lower your interest rate.

Each point costs a fee equal to 1 percent of the loan amount and
typically reduces your mortgage rate by about one-eighth of a
percentage point. So if you’re borrowing $250,000 and the standard
interest rate is 4.00 percent, you can buy a point for $2,500 and
reduce your rate to 3.875 percent.

Negative points are sometimes used as a way to pay for closing
costs and other fees. So, in the example above, taking a single
negative point would raise the interest rate to 4.125 percent to
defray $2,500 in closing costs and fees.

Down payment

The size of your down payment may affect your interest rate. For
lenders, a smaller down payment means a riskier loan, so they tend
to charge higher rates. However, if you put less than 20 percent
down, you’ll have to buy private mortgage insurance (PMI). This
gives the lender some protection in the event of a default, making
the loan less risky. In fact, in some cases you may even get a
better interest rate than someone who puts down 20 percent.

Keep in mind, though, that the annual charge for PMI is equal to
about one-half percent of the amount borrowed, so it’s like raising
your interest rate by half a percent. Also, the rate will likely
vary for both PMI- and non-PMI loans. For example, someone putting
down 5 percent may pay a higher rate than someone putting down 10
percent while someone putting down 30 percent will likely get a
better rate than if they’d put down 20 percent.

Lender

Some people overlook this, but the interest rate you pay will
vary according to the lender you go with. Lenders participate in
different lending programs and structure their loans and fees in
different ways. The lender who provides the lowest interest rate
for a friend may not have the best deal for you. This is why it
pays to shop around for a mortgage – you don’t know who will have
the best deal until you compare several offers.

Notice too, that you’re looking for the best deal – not
necessarily the lowest mortgage interest rate. Because of the way
different fees and closing costs get folded into a loan, a mortgage
with a seemingly low rate could actually end up costing you more
over the long run than another with a slightly higher rate, because
you’re paying more fees up front. A convenient way to check this is
to compare the annual percentage rate (APR) on different loan
offers, which is a way of estimating the total cost of a loan.