You found a great neighborhood, you’re ready to buy a home and, lo and behold, you make an offer and it gets accepted. Now you’re probably wondering, “What is this going to cost me every month?”
The fact is, your monthly payments aren’t just based on the cost of the home loan. They’re also based on the interest rate of your mortgage.
So the question you should really be asking yourself is, “How do I get a lower interest rate on my mortgage?”
How To Get a Low-Interest Mortgage Loan
Your interest rate will be affected by the stock and bond markets, the Federal Reserve and other things you can’t control. But there are key factors that you can control that also help determine the interest rate. To get the lowest interest rate possible:
- Build good credit and financial history
- Get advantageous loan terms
- Look for outside assistance
Let’s take a look at how you can work the system to get the most affordable mortgage rate possible.
Have Good Credit and Financial History
The first thing lenders want to know is whether they can trust you to make your monthly mortgage payments. To do that, they use your credit history to try to decide if you’re a risk. Lenders will be paying close attention to:
The first thing a lender will do is pull your credit report and look at your credit score. Rates range from 300 (poor) to 850 (excellent). The higher your credit score, the better your mortgage rate.
Lenders have different standards, but 620 is usually considered the lowest credit score needed for most mortgages.
If your credit score isn’t where you want it to be, you can improve it by:
- Paying your bills on time and in full
- Paying off high-interest debt
- Paying off your card every month if you don’t already have debt on it
- Consolidating debt with a low-interest loan
- Reviewing your credit report for errors
- Keeping old accounts open, using them for small charges and paying them off right away
- Limiting your requests for a new loan or credit card to avoid hard inquiries
Keep your debt-to-income ratio (DTI) low, low and low
Lenders want to make sure you’ll be able to pay all of your bills and that you’re in a good financial position to take on additional debt.
Before you run off screaming into the abyss, your DTI is really a simple fraction problem. It’s not that hard to figure out. Honest!
Debt-to-Income ratio = Your Monthly Current Debt / Your Current Monthly Income
Let’s say you have the following monthly debts:
- Car payment: $200
- Student loans: $250
- Credit cards: $550
- TOTAL: $1,000
And your monthly pre-tax income is: $4,000
$1,000 / $4,000 = 25% DTI
Most mortgage lenders prefer a DTI of 36% or less. So if your DTI is high, look for ways to pay down your debt and get a better rate that way.
Get a job, keep a job: Income history
Lenders want to see if you can hold down a job or earn enough each month to pay your mortgage. The better your job history, the more lenders will trust you. To check this, most lenders will accept pay stubs, and some can automatically verify your income status online.
If you’re self-employed or work multiple jobs, you may be making a great living, but you’d still be at a disadvantage compared to someone with a 9-to-5. So be ready to provide extra documentation like tax returns and income statements.
Understand Your Loan Terms
Another way to get a lower mortgage interest rate is to understand how your mortgage works. That way you can pick the type of mortgage that’s right for you and see how your mortgage best fits with your long-term spending, saving and homeownership goals.
Type of loan
Instead of a fixed-rate mortgage, where you pay a consistent interest rate over the life of the loan, there is also the option to take out an adjustable-rate mortgage (ARM).
With an ARM, you can get a lower introductory rate for the first 3 – 10 years, and then pay a variable rate after that. There is a risk that the interest rate will go up significantly after the introductory period, but these loans can be advantageous for short-term buyers or those with less than perfect credit.
Life of the loan
Lenders often offer better interest rates if you choose a shorter loan term rather than the typical 30-year mortgage because they’re taking on the risk for a shorter amount of time. If you can afford to make a larger monthly payment, consider a shorter 10-year or 15-year mortgage. You’ll pay more each month, but you can build equity in your home faster and pay less interest in the long run.
Down payment: More is better
The more you put down for a down payment, the cheaper your mortgage will be. Because you are borrowing less, the lender feels like you’re a surer bet.
A down payment of 20% or more helps lower your interest rate and saves you money because you won’t have to pay for private mortgage insurance. Sounds like a great deal, right?
Mortgage discount points: Make your mortgage cheaper
Mortgage discount points are like paid upgrades in your favorite freemium game. They cost you more upfront, but make it possible to win more in the long run.
If you have money left over after paying 20% down, you can save money by buying mortgage discount points.
Here’s the formula you’ll need to calculate mortgage discount points:
1 mortgage discount point is 1% of the purchase price of the loan and lowers your interest rate by 0.25%
It may not seem like much, but let’s crunch the numbers:
Let’s say you’re about to buy a home. You’ve covered your down payment and you suddenly come into some extra money, say $4,000. You have two options:
- Loan amount: $200,000 – $4,000 paid upfront = $196,000
- Interest rate without points: 4.5%
- Monthly loan payment: $993
Let’s say you take that $4,000 and buy 2 points:
- Loan amount: $200,000
- Interest rate with points: 4.0%
- Monthly loan payment: $955
That saves you $38 a month. That’s money you can use to pay bills, set aside for the future or buy an extra pizza each week.
It may not seem like much, but the points pay for themselves after 10 years. At the end of a 30-year mortgage, you’ll have saved almost $14,000, which is a nice chunk of change.
Like Goldilocks, lenders usually prefer loans that are just the right size, big enough to earn a profit, but not so big that they carry high risk.
Most conventional mortgage loans tend to range between $100,000 and $548,250. Why $548,250? It’s the Federal Housing Finance Agency (FHFA) maximum conforming loan limit for a 1-unit property (though that number can go as high as $822,375 in certain high-cost areas).
If you’re looking at a property that is priced just over the FHFA limit, you may be able to lower your interest rate by making a larger down payment to bring the loan under the limit.
These are the fees and expenses that you will need to pay as part of the mortgage process. These fees can add thousands of dollars to the total cost of your mortgage.
Be prepared to haggle. Your lender may be open to negotiating these down, especially if they don’t want to lose your business. The more qualified you are for your mortgage, the more lenders may be open to making a deal.
Get Outside Help
FHA loans or VA loans
If you’re a first-time home buyer, have past income and credit issues or are a veteran or active-duty member of the U.S. Armed Forces, you may qualify for lower interest loans that are backed by the federal government.
You’ll need to meet specific criteria to qualify, but these loans can provide a chance at a better mortgage rate if you have a credit score of 580 to 619 or a DTI of 36% to 43%.
First-time home buyer programs
Many states offer first-time home buyer programs to help you:
- Navigate the home buying process
- Find down payment assistance
- Connect with special mortgage programs offering affordable interest rates
- Take advantage of tax credits that make it easier to afford a home
Keep in mind, some of these programs may be designed to encourage homeownership in low-income areas, or assist home buyers in certain professions, such as teachers and first-responders. You’ll need to know what the program requirements are and if your lender offers these types of loans.
Find a co-signer or co-borrower
If your credit score is making it harder to get an affordable interest rate, adding a co-signer or co-borrower can help.
- A co-borrower is someone who shares ownership of the home and takes responsibility for the mortgage with you from the start
- A co-signer doesn’t share in ownership of the home but agrees to take responsibility for the mortgage if you miss your payments
Whether you choose a co-borrower or co-signer, they should have excellent credit, and you should both understand what you’re signing up for.
Many family feuds have started with a handshake over co-signing, so be sure that you want to go down this route. Let’s not make it awkward at the next family reunion.
Lower mortgage rate: achieved
Getting a good mortgage rate doesn’t have to be complicated. If you can present yourself in the best light, understand the process and get the right support, you can become a homeowner while saving money.