When you’re buying a home, the sale price is just one piece of the financial puzzle.

The interest rate you get on your mortgage is just as important a factor in determining how much you’ll pay each month—and how much you’ll spend over the life of the loan. Even small fluctuations in available rates can significantly affect your budget, making it essential to understand their impact before signing on the dotted line.

Understanding mortgage rates

Expressed as a percentage of the loan amount, a mortgage rate represents the cost of borrowing money from a lender. This number can be higher or lower depending on a variety of elements, primarily broader economic conditions such as inflation, Federal Reserve policies, and overall economic growth. When the economy is thriving, rates often increase as lenders seek to balance demand; in contrast, they may decrease in slower economic times to encourage borrowing.

Your financial profile also plays a crucial role in the rate you’re offered. Lenders review every applicant’s credit score, debt-to-income ratio, down payment size, and more to assess the level of risk associated with providing a loan. Buyers with better income and credit who plan to put a significant amount down typically receive more favorable rates, even in a bad market, while those in worse standing may face higher ones.

The impact on monthly payments

Your monthly mortgage payment is made up of four primary components: the principal, interest, taxes, and insurance. Of these, the interest rate can be the biggest wild card. Consider a $250,000 loan on a 30-year fixed-rate mortgage. With no down payment, a rate of 5 percent would yield a monthly mortgage payment for principal and interest alone of approximately $1,342. However, if you instead get a rate of 6 percent, that amount would rise to about $1,499. That’s an additional $157 each month, or nearly $1,884 per year.

This difference highlights how even a single percentage point change can impact your budget. Also note that a higher rate means a larger portion of your payment goes toward interest rather than reducing the loan’s principal balance.

Strategies for managing mortgage rates

While you can’t control market conditions, there are steps you can take to help get a more favorable rate and minimize the impact of a higher one. Improving your credit score is one of the most effective strategies since it can present you as a less risky borrower, which often results in better loan offers. While it’s no guarantee, actions like paying your bills on time, reducing your debt, and avoiding new credit inquiries may help your number tick up over time, putting you in a better financial position.

Choosing the right type of mortgage is also critical. Fixed-rate mortgages offer stability with consistent monthly payments, while adjustable rate-mortgages (ARMs) typically start with lower interest rates. The key is to factor in both the current market and your plans for the home. For instance, the first option can be ideal for those who plan to stay in their homes long term and are buying at a time when rates are low. But if they’re on the high side, you might consider an ARM with either the expectation that they’ll come down in the future or the intention to refinance before your rate adjusts.

Lastly, timing your purchase can make a difference. If you’re not in a rush to buy, consider sitting on your plans while you monitor rate trends. As indicated earlier, purchasing when you have a better shot at a lower rate can significantly reduce your costs both now and in the future.

The big picture

While mortgage rates are a major factor in determining your monthly payment, they’re just one aspect of the homebuying process. Balancing your budget, savings, and long-term goals will help you make an informed decision that aligns with your financial situation. Be sure to work with a trusted real estate professional and mortgage lender to navigate the complexities of the market and secure the best terms for your dream home.