How Much Does Interest Rate Affect Monthly Payment?

For those looking to move from an apartment in Glendale, California to a home in Sherman Oaks or outside the state, mortgage interest rates are a crucial factor to consider. These rates directly impact the monthly payments you’ll make on your loan. How much does interest rate affect monthly payment? You might be asking, especially now that interest rates have finally decreased. We’ll answer that and more here.

Understanding how interest rates work and how they can affect your finances is essential for making informed decisions about homeownership. In this Redfin article, we’ll explore the basics of mortgage interest rates, how they influence your monthly payments and strategies for managing them. Now, let’s get started.

1. Understanding interest rates

First, let’s talk about what interest rates are and how they work.

Mortgage interest vs principal

When you take out a mortgage, you borrow money from a lender to purchase a home. In return, you agree to repay the loan over a set period, plus interest. The principal is the original amount you borrowed, while the interest is the additional cost you’ll pay for using the lender’s money.

Fixed-rate mortgage vs adjustable-rate mortgage

There are two main types of mortgage interest rates: fixed-rate and adjustable-rate.

A fixed-rate mortgage has an interest rate that remains the same throughout the life of the loan. This means your monthly payments will be consistent.
An adjustable-rate mortgage (ARM) has an interest rate that can change over time, typically based on a specific index. This means your monthly payments could increase or decrease depending on market conditions.

Non-qualified mortgage loans

Non-QM (non-qualified mortgage) loans are a type of mortgage that doesn’t meet the strict underwriting guidelines established by Fannie Mae and Freddie Mac. These loans are often offered to borrowers who may not qualify for traditional mortgages due to factors such as a lower credit score, higher debt-to-income ratio, or unconventional income sources.

Nicholas Hiersche, president of The Mortgage Calculator in Miami, Florida shares, “Although non-QM loans typically come with higher rates, the flexible income guidelines enable borrowers to qualify with more income, providing an essential option when conventional rates are out of reach.”

2. The impact of interest rates on mortgage payments

The interest rate on your mortgage directly affects your monthly payment. A higher interest rate means you’ll pay more in interest over the life of the loan, resulting in higher monthly payments. Conversely, a lower interest rate means you’ll pay less interest, leading to lower monthly payments.

Ryan Leahy, senior loan officer for Leahy Lending shares that “Even a small change can significantly impact the overall cost of your loan.” Leahy adds, “Homebuyers should know that a 1% interest rate drop can increase their buying power by 10%, allowing them to afford more home for the same monthly payment.”

To illustrate this, let’s consider two hypothetical scenarios:

Scenario 1: You take out a $300,000 mortgage with a 30-year fixed interest rate of 5%. Your monthly payment would be approximately $1,610.
Scenario 2: You take out the same $300,000 mortgage but with a 30-year fixed interest rate of 4%. Your monthly payment would be approximately $1,432.

In this example, a 1% difference in interest rates results in a monthly savings of $178. Over the life of the loan, these savings can add up significantly.

3. Strategies for managing interest rates

Want to take advantage of interest rates in this current market? Let’s look at factors that impact rates and how to negotiate.

Factors that can lower interest rates

Several factors can influence the mortgage rate you’ll receive on your mortgage and without a doubt you’re likely shopping to get the best mortgage rate. Factors that can lead to lower interest rates include:

Credit score: A higher credit score generally leads to a lower interest rate. For those looking to improve their credit scores, Roland Wilcox with Sierra Capital Mortgage in Pasadena, California suggests “consistently paying bills on time, keeping your credit card balances below 30% of your credit limit, maintaining older accounts, and diversifying your credit cards.”
Down payment: A larger down payment can also help you secure a lower interest rate.
Loan term: Longer loan terms often result in lower monthly payments but higher overall interest costs.
Mortgage type: Certain mortgage types, such as government-backed loans, may offer lower interest rates.

Negotiating your interest rate

It’s worth negotiating with your lender to see if you can secure a lower interest rate. They may be willing to offer a better deal, especially if you’re a strong borrower with multiple offers from other lenders.

Refinancing your mortgage

If interest rates have dropped significantly since you took out your mortgage, refinancing may be an option. This involves taking out a new loan to pay off your existing mortgage. If the new interest rate is lower, you can potentially reduce your monthly payments.