FHA mortgage rates are determined by the current market rate of interest for loanable funds, and also the banks willingness to lend money to borrowers. The rate one person pays for an FHA loan may vary greatly from another person, partially due to regional differences, and partly to do with the credit of the borrower in question.
FHA mortgages are one of the most secure products banks will invest in to make money for their depositors. FHA loans through the Federal Housing Authority are backed by the credit of the United States government, meaning that the loan is insured against default, thus making them safe investments for banks.
To supply this guarantee to lenders, the FHA has a mortgage insurance program that is generally flat rate from borrower to borrower. As you may or may not know, mortgages require mortgage insurance to protect banks against default for any loan in which the borrower does not have at least 20% equity, or place a 20% down payment on a home.
FHA Mortgage Rate Calculation
FHA mortgage rates are determined by the current prime rate of interest, which is published each Friday in the Wall Street Journal. The prime rate is the rate at which banks lend US dollars to other banks. When banks loan money to consumers, a bank uses this rate then marks up the rate of interest to protect against risk, and create a profit in lending money to borrowers.
From there, banks base the rate of interest on the borrower’s current financial condition. The FHA has no minimums for credit quality, however borrowers should be sure to maintain a credit score of at least 580, with 620 or higher being the preferred “high water mark” for any loan. Having a better credit score shows the bank that you have the responsibility necessary to make monthly payments for the next 15-30 years, depending on the mortgage loan term.
FHA mortgage rates are also affected by the upfront costs of borrowing money. For example, you can receive a smaller interest rate should you decide to buy “points” on your mortgage, effectively prepaying the interest rate. Other points exist to cover the mortgage company’s costs, and generally pay for the cost of writing the loan.
At some point you may have to determine whether you should pay for a point on your mortgage for a lower rate, or whether a higher rate is a better solution. In general, this is a conversation that should include your current tax situation, your prospect of living in the same place for a long period of time, and your ability to pay upfront when signing onto a loan. Most first time home buyers do not have the cash to put down a 3.5% down payment plus additional cash for points. Instead, they may choose to take the higher rate but with fewer upfront origination costs.
Fixed and Variable Rates
A major determinant in the quest for an affordable mortgage is the difference between a fixed and variable rate loan. In the beginning of a loan period, a fixed rate loan will be the most expensive, since the rate is locked in and the bank has to guarantee this rate, either by purchasing insurance against rising rates, or by borrowing money for longer periods of time to supply you with your fixed rate loan.
A variable rate loan will always start out at a rate lower than a fixed rate loan. It will not, however, always stay that way. FHA borrowers who accept a variable rate loan will see their mortgage payment rise and fall with the general trend in interest rates. Those who plan to live in their home for only a short period of time benefit from a variable rate. Those who plan to live in their home for a very long time would benefit more with a fixed rate loan.
Remember that your FHA mortgage can be refinanced at any time, which will allow you to reduce your rates on a fixed rate mortgage even if interest rates rise considerably.