How do Lenders Set Interest Rates on VA Loans?

Kid waving a flag

When you shop for a loan, chances are the main priority is the interest rate. You want the lowest interest rate available, right? It makes sense, since the interest rate determines how much the loan costs you over the lifetime. It also determines the amount of your monthly payment on top of the amortized principal.

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Did you know that the VA doesn’t play a role in the interest rates charged on their loans? That’s because they don’t fund the loans – the lenders do. Since the lenders are ‘in charge’, they set the rates. So what do lenders look at to figure out your rate? Take a look at the factors below.

Your Risk Level Matters

Lenders look closely at your risk level. How likely are you to make your mortgage payments? That’s how they determine your interest rate. They call it ‘ risk-based pricing.’ They have a base rate they must charge in order to make money from the secondary market (investors that buy your loan). But lenders will often add to that rate based on your risk.

Following are the most evaluated factors:

  • Credit score – Your credit score is the lender’s first impression of your financial responsibility. A high credit score often means you make good financial decisions. A low credit score often means you have financial issues, such as late payments, overextending your credit, or even bankruptcies/foreclosures. You want to get your credit score as high as possible in order to increase your chances of a lower interest rate.
  • Debt ratio – Your debt ratio lets lenders know how much of your income is already spoken for each month. If you are adding a mortgage to your debts, the lender wants to know that the housing payment doesn’t make your debt ratio soar. They also want to make sure you don’t have so much other debt that you will have trouble making your mortgage payment. You want your debt ratio as low as possible in order to increase your chances of a low-interest rate.
  • Down payment – VA loans don’t require a down payment, but that doesn’t mean you cannot make one. If you put money down on the home, you have a vested interest in the home. This means you are more likely to do what you have to do to make your mortgage payments. Having a little ‘skin in the game’ can help you secure that low-interest rate.
  • Employment – Technically, the VA requires that you have a 2-year job history. They would prefer if it were with the same employer. If you had a job change within the last 2 years, you may be able to still get approved, but you may pay a higher interest rate because of it. Changing jobs shows lenders inconsistency, which is the last thing any lender wants. If you change jobs within the same industry, though, and do so in order to secure higher pay, it could help your case.

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Shop Around

The most important thing you can do when choosing your interest rate is shop around. Each lender has a different threshold for risk, so they will have different rates available. As you shop around, compare the rates, APR, and terms of the loan. You can then put all of the pieces of the puzzle together to figure out which loan works the best for you.

Sometimes it’s not the loan with the lowest interest rate, but the loan with the lowest fees and best terms. Remember, you may carry this loan for the next 30 years; make a wise financial decision so you can achieve financial peace moving forward.

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