Understanding how interest rates affect your monthly mortgage payment and the overall cost of your loan is a great start towards determining which mortgage is right for you. In this post, we’ll cover the basics of why interest rates change and what you need to look out for when shopping for a mortgage.

Where do interest rates come from?

Most of the movement in interest rates comes from the central bank, in the United States, the Federal Reserve. For several reasons, including controlling inflation or boosting economic growth, the Federal Reserve will decide it is in the country’s best interest to move the target rate interest rate up or down. They’re able to do this by influencing the supply and demand of loans in the market. If the Fed makes it cheaper for banks to borrow money, then your lender can pass those savings on to you. If the Fed makes it more expensive for banks, then your costs will rise as well. While the Fed makes the ultimate decision, the general idea is that rates rise when the economy is growing quickly and lower when it slows down.

What is an interest rate?

In the simplest of terms, interest is the money you pay to a lender for the privilege of borrowing their money. Interest rates are shown as a percentage.

Even 1/10 of a percent can make a big difference

For most people, their primary home mortgage will be the largest loan they’ll carry in their life. Home loans are typically hundreds of thousands of dollars or more. With a loan of this size, even a small shift in your interest rate can have a significant impact on both your monthly payment and the overall cost of your mortgage. This is why taking advantage of low rates is a big deal and why many homeowners refinance their mortgage to get a better rate.

Other factors that affect interest rates

While the Fed influences the overall trend for interest rates in the market, it’s important to remember that the rate available for any individual borrower will vary, based on creditworthiness, home price, home location and other factors that raise or lower the perceived risk for the lender. If a borrower is seen as low-risk, they’ll be offered a lower rate. If a borrower or the purchase being made is seen as high-risk, the offered rate will go up.

Beyond the interest rate

It’s important to note that a lot more goes into structuring a mortgage than the interest rate. Generally, a lower rate is better than a higher one, but you can’t always compare two competing mortgage options based solely on the interest rate. Factors such as the loan term, interest rate type (fixed or variable), loan type (conventional or government-backed) and loan fees can also impact the total cost of a mortgage–and competing loans can cost the buyer a different amount depending on when they plan to pay off the remaining principal.

Be sure to discuss your current and future plans with your mortgage broker. Always look at the total package and how the mortgage structure matches with your life and goals.

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