Your mortgage rate can have a significant financial impact on your monthly budget and the overall cost of purchasing your home. For this reason, it’s essential to take the time to understand how to secure the lowest mortgage rate possible. Here are some tips on how to compare mortgage products, understand how to pay points, and learn ways to improve your financial position to get the most competitive rates.
Shop Around
Shopping around is crucial when looking for the best mortgage rate, especially when buying a high-value home. You’ll want to obtain a few pre-approval letters to compare rates and ensure you’re getting the best loan for your situation. You have two options:
Use a mortgage broker. A broker knows how to find the best mortgage rate and can provide you with multiple offers at once. However, you need to be cautious as they technically work for the lenders, and you will pay a fee to the broker, so you should do your due diligence.
Request quotes yourself. Once you are serious about moving forward, you can fill out a few loan applications (allowing lenders to perform a hard credit check) to get pre-approval letters. These letters will specify the amount you can borrow and the agreed-upon interest rate. But remember, a more detailed review of the application will come later, so pre-approval is not a guarantee.
Once you have a few offers, look at the interest rates and annual percentage rates (APR) for each. The APR includes most of the fees you will pay, including origination fees, mortgage insurance, and some closing costs and discount points, so you’ll get a more accurate picture of the total loan cost. In other words, just because a loan has a lower interest rate doesn’t mean it’s the better deal. However, the mortgage interest rate is what determines how much you will pay monthly, making it a critical part of your decision.
Comparing Mortgage Products
When shopping around, remember that there are different types of mortgages available. A traditional 30-year mortgage may be the most common (accounting for 78% of closed loans in December 2021), but it may not be the best option for every consumer.
Here are some types of mortgages to consider:
Different Terms
The longer the term, the higher the interest rate, but the lower the monthly payment. However, a shorter-term mortgage comes with lower interest rates, meaning you will pay less in interest over the life of the loan. For some consumers who can handle a higher monthly payment, it may make sense to explore a 15-year mortgage. Some lenders may also offer 20-year loans or loans with other terms.
Fixed-Rate vs. Adjustable-Rate Mortgages
For buyers who prefer to have the same principal and interest payment over the life of their mortgage, a fixed-rate loan is the ideal choice. For a certain class of buyers looking to reduce risk, an adjustable-rate mortgage may be more appealing. An adjustable-rate mortgage typically starts with a lower rate than a fixed-rate mortgage. However, the rate will change (either higher or lower) at specified intervals. If you only plan to stay in the home for a short time, an adjustable-rate mortgage might be a money-saving option.
Conventional Loans vs. Government-Backed Loans
Conventional loans and government-backed loans such as FHA, VA, and USDA loans have their advantages and disadvantages. When it comes to interest, government-backed loan programs may sometimes have more competitive rates since there is less risk for the lender. However, there are also other factors to consider regarding government-backed loans, such as upfront fees and mortgage insurance costs; different credit score and income requirements and/or military service; and restrictions on the type or location of the home.
Improving
Your Financial Position
Now that you have a good idea about the available loans, it’s time to put your best financial foot forward. Since your interest rate largely depends on your credit situation and your income-to-debt perspective, it is within your control – and in your best interest – to improve your financial position before you start shopping for a home.
Improving Your Credit Score
Your credit score is one of the key factors lenders consider when determining your mortgage rate. From their perspective, individuals with strong credit are less likely to default on their loans, and therefore, these borrowers have lower interest rates. If you are looking for a home loan, you should regularly monitor your credit score, which is usually available for free through your credit card or bank accounts. You should also obtain your credit reports from the three major credit bureaus (Experian, Equifax, and TransUnion) for free at annualcreditreport.com. These reports will give you a more detailed picture of the factors that may affect your credit score.
The good news is that achieving a higher credit score is attainable. First and foremost, you should pay your bills on time every month, as payment history is the most significant factor in calculating your credit score. The next major factor is credit utilization, or the amount of debt compared to your available credit. In other words, paying down your balances can help improve your credit score. There are also more advanced ways to boost your credit; a credit counselor or financial advisor can assist you in this regard.
Reducing Your Debt
Your debt-to-income (DTI) ratio is another key benchmark that lenders consider when determining your mortgage rate. This refers to the percentage of your income that goes towards paying your debts each month. Generally, conventional loans require a DTI of 36% or less, although lenders might allow a ratio as high as 45% if the borrowers meet a higher credit threshold and cash reserves. FHA loans require a DTI of 43% or less, while the maximum for VA loans is 41%.
You can improve your DTI ratio by reducing the amount of debt you owe. If you can do this, it will put you in a better position to qualify for a lower mortgage interest rate.
Increasing Your Income
Another component of your DTI is your income, so if you can earn more, that will also improve your ratio. Asking for a raise is one way to increase your income before applying for a loan. You might also consider taking on extra work or starting a side job.
Saving for a Larger Down Payment
Putting more money down on a home – that is, reducing your loan-to-value (LTV) ratio – means a smaller loan amount and thus less risk for the lender. If you can do this, an LTV of 80% or less (meaning putting 20% or more down on the home) means you won’t have to pay private mortgage insurance (PMI). Saving for a down payment requires commitment and time; just try not to deplete your cash reserves entirely because you will need some money in the bank for future expenses.
Note: Programs like FHA and VA have different standards when it comes to LTV, so work with a mortgage professional who can fully explain your options.
Paying Points to Lower Your Interest Rate
Method
Another way to lower the interest rate is by paying discount points. Typically, one point costs 1% of your loan, and usually, each point you pay reduces the interest rate by 0.25% (the exact amount of the reduction may vary by lender).
Source: https://www.thebalancemoney.com/how-to-find-the-best-mortgage-rate-5268127
Leave a Reply