Mortgage Ratings: Understanding The Emortgage Rating System

E-mortgage ratings are influenced by several factors, including economic conditions, personal circumstances, and property attributes. Economic factors such as inflation, bond market dynamics, and Federal Reserve policies impact the interest rates offered by lenders. On the other hand, an individual's credit score, debt-to-income (DTI) ratio, and loan-to-value (LTV) ratio are crucial in assessing their mortgage rate. A higher credit score generally leads to a lower mortgage rate, while a higher LTV ratio indicates higher risk and interest rates. Additionally, the type of property and its energy efficiency, as indicated by EPC ratings, can also affect mortgage rates and eligibility. Overall, e-mortgage ratings are determined by a combination of economic, personal, and property-related factors, which influence the interest rates and eligibility for loans.

Credit score

A credit score is a numerical representation of an individual's creditworthiness. It is based on factors such as payment history, total debt, types of credit used, and length of credit history. Credit scores typically range from 300 (lowest) to 850 (highest), with a higher score indicating a better credit history and lower risk for lenders.

Lenders use credit scores to evaluate the risk of lending to an individual and determine the interest rate they will offer. A higher credit score generally leads to lower mortgage rates, as lenders perceive the borrower as lower risk. Even small differences in credit scores can significantly impact the mortgage rate offered. For example, a score of 740 typically secures the lowest rates, while a score of 620 is often the minimum required for most home loans.

An individual's credit score is calculated based on information in their credit report, including their credit usage, length of credit history, types of accounts, and recent activity. Credit usage considers the number of accounts with balances, the total amount owed, and the credit utilisation rate. Length of credit history includes the average age of accounts and the age of the oldest and newest accounts. Types of accounts refer to managing both instalment and revolving accounts, such as loans and credit cards. Recent activity includes applications or openings of new accounts.

It is important to note that credit scores can change monthly and that lenders use different criteria to evaluate risk. Therefore, it is recommended to improve one's credit score before applying for a mortgage and to check one's credit report for any errors. Maintaining a good credit score can increase the likelihood of approval for a mortgage and result in lower interest rates and down payments.

Inflation and economic growth

Inflation refers to the increase in prices for goods and services over a certain period, typically a year. It is often measured by tracking the cost of specific goods and services. Inflation can be caused by several factors, including supply and demand imbalances, production cost increases, monetary policy, and economic growth.

The relationship between inflation and economic growth is complex and has been widely studied but remains not well-defined. Some studies, like the one conducted in Burundi, found a negative relationship between inflation and economic growth in the short run. In the long run, however, the same study found a positive correlation between investment, household consumption, and exchange rate with economic growth. It also determined an inflation threshold of 13% above which inflation starts to harm economic growth.

Other studies, such as those by Andrés and Hernando, concluded that even low or moderate inflation rates have a temporary negative impact on growth rates, leading to significant and permanent reductions in per capita income. They found that a reduction in inflation, even by a single percentage point, leads to an increase in per capita income of 0.5% to 2%. This suggests that keeping inflation under control is crucial for better long-term economic performance and higher per capita income.

Monetary policies play a crucial role in managing inflation and guiding the economy towards stable growth. Central banks and governments use monetary and fiscal policies to influence the money supply in the economy, control inflation, and stimulate economic growth. Fiscal policy involves taxation and federal budgeting, while monetary policy includes actions such as adjusting interest rates.

Inflation can have several effects on the economy and individuals. It leads to a loss of purchasing power as goods and services become more expensive. It can also increase home prices and interest rates, impacting buyers and homeowners. Additionally, inflation can slow down the economy and, if left unchecked, lead to a recession or even hyperinflation.

Loan-to-value ratio

The loan-to-value (LTV) ratio is a measure that compares the amount of money borrowed with the appraised value of the property. Lenders use the LTV ratio to assess the level of exposure to risk they take on when underwriting a mortgage. A high LTV ratio indicates a higher risk of default for the lender, as there is very little equity built up within the property.

The LTV ratio is calculated by dividing the loan amount by the value of the property. For example, if you are looking to buy a $350,000 home and have $28,000 for a down payment, the loan amount would be $322,000 ($350,000 - $28,000). Dividing the loan amount by the cost of the home gives an LTV ratio of 92% ($322,000 / $350,000 = 0.92, multiplied by 100 to get the LTV percentage).

A good LTV ratio is generally considered to be 80% or lower, with anything above this threshold considered a high LTV. A lower LTV ratio indicates a lower risk for the lender and can result in a lower interest rate for the borrower. It also increases the likelihood of loan approval and reduces the need for private mortgage insurance (PMI).

If the LTV ratio exceeds 80%, borrowers may face higher borrowing costs, be required to purchase PMI, or even be denied a loan. LTV ratios above 95% are often considered unacceptable. For example, if you buy a home appraised at $100,000 and make a $10,000 down payment, the resulting LTV ratio is 80% ($80,000 loan / $100,000 value = 0.80, multiplied by 100).

The LTV ratio is a critical factor in determining eligibility for securing a mortgage, but it is not the only consideration. Lenders also evaluate other aspects of the borrower's financial profile, such as credit score and debt-to-income ratio, to assess the overall risk of lending.

In recent years, there has been a growing focus on energy efficiency and its impact on mortgage ratings. Lenders have introduced specific EPC (Energy Performance Certificate) mortgages and green mortgages, which offer incentives for purchasing energy-efficient homes or making improvements to existing properties to increase their energy efficiency. A high EPC rating can lead to cashback offers or better rates on mortgages, while properties with low EPC ratings may find it increasingly difficult to secure mortgages.

Energy efficiency

An Energy Performance Certificate (EPC) rating is a measure of a property's energy efficiency. EPC ratings range from A (most efficient) to G (least efficient), with properties in the former band known for their lower bills and carbon emissions. The EPC will also tell you the estimated energy costs and carbon dioxide emissions of a property.

A property's EPC rating can influence its value, with higher ratings often correlating with lower energy costs and increased desirability. This means that homes with better EPC ratings may command higher market values. As a result, lenders may offer better interest rates or lending terms for properties with higher EPC ratings.

Some lenders are now offering "green mortgages", which provide a lower rate for customers in energy-efficient homes, typically those rated C and above. These mortgages can also offer cashback on top of lower interest rates. Green mortgages are not necessarily cheaper than standard mortgages, and eligibility criteria may vary, so it is important to check with your mortgage provider.

There are also energy-efficient mortgages, which can help people buy or renovate homes with energy-saving upgrades. These tend to have better rates than other fixed-rate mortgages, and the cost of an energy assessment can be rolled into the mortgage.

To improve a property's EPC rating, owners can make energy-efficient improvements such as installing insulation, upgrading to double or triple-glazed windows, draught-proofing, and installing solar panels.

Monetary policy

Mortgages are long-term loans with regular nominal payments. The interest rate charged to a borrower on a mortgage is called the mortgage rate, which can be either fixed or variable. Mortgage rates are determined by several economic and personal factors, including inflation, credit score, level of economic growth, and loan-to-value ratio.

The transmission mechanism of monetary policy is stronger under adjustable-rate mortgages compared with fixed-rate mortgages. When policy rates rise, monthly mortgage payments for homeowners with adjustable-rate mortgages also increase, depressing disposable income and sometimes consumption, through the "cash flow channel". Home prices are also sensitive to changes in interest rates, which can impact how much buyers are willing to borrow and for how long, affecting housing prices.

Additionally, persistently higher inflation gradually benefits homeowners under fixed-rate mortgages but hurts those under adjustable-rate mortgages. Higher inflation redistributes income from capital owners to homeowners under FRM, but from homeowners to capital owners under ARM.

Frequently asked questions