Your mortgage interest rate can significantly impact the total amount of money you pay over the life of your loan. Because homes are meant to be an investment as well as a place to live, it is important that you pay as little interest as possible to reap the full benefit of home ownership. Follow these steps to help secure the best possible mortgage rate.
Step One: Improve Your Credit Score
Your credit is one of the most important factors in determining your mortgage interest rate. Banks use your credit as a judge of how likely you are to pay your mortgage based on how well you've paid past and current debts. In order to receive the best interest rate possible, you'll want to have a very good credit score (740-799) or an excellent credit score (800-850).
Build Credit
If you don't have much credit, odds are that you will not be approved for a mortgage. This is because you won't have enough of a credit history for the bank to determine how likely you are to pay back their loan. If you are approved without having much credit in the past, it will probably not be at a favorable interest rate.
One of the best things you can do to start building credit is to get a secured credit card. This will establish a credit line that will impact your score positively as long as you pay the monthly fee on time.
Pay on Time
Paying your monthly debts on time is the number one factor in determining your credit score. If you are in dire straits and need to choose between what you are going to pay in a month, always pay your mortgage first (assuming you already have one). It is usually the biggest loan you have and impacts your score the most.
New Debts
If you know that you're going to be applying for a mortgage soon, do not take on any new debts. New credit cards and car loans bring your score down right away, and they will also affect your debt-to-income (DTI) ratio. The better your DTI ratio, the better interest rate you'll receive.
Old Debts
If you have debts that have gone into collections, it is best to pay them off before applying for a loan because they drag your credit score down. If you think your credit score is lower than it should be, ask your lender for a copy of your report to ensure that all old debts have fallen off like they should have. Sometimes you will need to contact credit agencies if they are still reporting old debt that should have fallen off.
Multiple Inquiries
Every time you apply for a new loan, your credit is pulled by the lender. Each time your credit is pulled, your score goes down a small amount. For this reason, it's important to pull your credit within a short period of time when shopping lenders (no more than a few days apart) so that it only counts against your score as one inquiry instead of several.
Foreclosure and Bankruptcy
If you had a loan in foreclosure or you have filed for bankruptcy, it is still possible to obtain a new mortgage if you are patient. Foreclosures fall off credit reports after seven years, and bankruptcies fall off after seven to ten years.
Although some lenders may offer you a mortgage with a bankruptcy still on your credit, it is generally better to wait. This is because you will get a much better interest rate without a bankruptcy on your report.
Step Two: Manage Your Finances
If you are interested in applying for a mortgage loan, you will need to prove to mortgage lenders that your finances are in good order. Not only should you maintain your job to prove your income, but you'll need to start saving your money if you haven't already. The better financial position you prove yourself to be in, the better the interest rate you'll receive.
Pay Off Debts
Not only will paying off debts improve your credit score, but it will also improve your debt-to-income ratio. Even if you have a current mortgage and your rate would be going down with a new loan, the bank has to assess the risk that you will default. This is why lenders do not approve home loans for consumers with more than a 43% DTI ratio.
Some mortgages, such as cash-out refinances, will allow you to use the equity in your home to pay off credit cards and car loans with the new mortgage, bringing down your DTI ratio.
Prove Your Assets
Having money set aside is important when you are in the market for a home loan. Lenders typically like to see that you have at least two times the amount of your monthly mortgage payment in the bank. Borrowers with assets may receive a better interest rate than others because they have proven that they are fiscally responsible enough to have saved money.
Save a Substantial Down Payment
If you're buying a house and you're able to save enough for a substantial down payment, that will also improve your position. The less you borrow against the value of your property, the better interest rate you'll be afforded.
Step Three: Find the Right Lender
Interest rates fluctuate with current market conditions, but you'll also want to shop around between at least three mortgage companies to see what rate they will offer you.
Start with Your Bank
Some banks will offer better terms to their own customers, so start by asking your bank for a rate quote. If you belong to a credit union, that should be your first stop due to their low fees.
Use Your References
If you know of someone who has recently bought a home or refinanced, ask them how the process went and if they received a good interest rate. If they had a good experience, ask for a referral to their lender. Referrals can be a great resource, because the information is coming from someone you know and trust.
Compare Loan Estimates
Interest rates are not the only consideration when it comes to how much a mortgage will cost you. Every mortgage company in which you apply for a loan must provide you with a Loan Estimate, formerly known as the Good Faith Estimate. On this form, you will find estimates for all the costs associated with your mortgage, including closing costs.
Beware of companies that offer a low interest rate but have very high closing costs. You can expect closing costs to range from two to six percent of the loan amount. Choosing a company that offers you low closing costs in addition to a fair interest rate will save you the most money.
Get the Rate Locked In
Interest rates fluctuate often, so if you're satisfied with the interest rate someone offers you, ask them to lock in your rate so that it doesn't increase while you're deciding if you want to use their company. Rate locks do expire, so be sure to you are aware of exactly how long your rate is locked in.
Ask About Loan Terms
If you're offered a very low interest rate but the rate is variable, that means that your rate will adjust every month after a certain period of time, and could potentially skyrocket if the market crashes. For this reason, a fixed interest rate is the safest option.
A short loan, such as a ten-year loan, will have a lower interest rate than a 15 or 30 year loan. Your monthly payment will be higher because you will be paying off your mortgage in a span of ten years instead of the usual 30 years. However, you'll be paying much less over time because you are only paying interest for the life of the loan, and at a lower rate.
Practice Patience
If you're in no hurry and interest rates have recently raised, you may want to wait until they are back in a more favorable position before you take out a new home loan. You can check on current mortgage rates on Bankrate.com.
Making the Most of Your Mortgage
A home is a substantial investment, and you should practice fiscal responsibility on that investment. Finding a low interest rate is an important factor for anyone who is thinking about refinancing or purchasing a home. Implementing these steps will ensure that you're taking the right steps for your future.
