For most Americans, buying a home is one of the most significant purchases they’ll make.
The median home value in the United States is $231,000, according to data through October 2019. Since most people don’t have that kind of liquid cash available, a mortgage — in which you borrow money from a lender and spend years paying it back, plus interest — is a necessary part of the home-buying process.
The terms of your mortgage matter greatly since the interest rate, type of mortgage and length of time you have to repay can dramatically impact the total amount you spend. Lower your rate by a percentage point or two or pay the mortgage off a few years early and you’ll save thousands in interest over the course of the loan.
“A home purchase will more than likely be the largest purchase completed in your lifetime,” explains Valerie Saunders, executive director of the National Association of Mortgage Brokers (NAMB). “It is important to shop around and make sure that the terms and conditions of the loan obtained will meet your needs.”
Aside from the rate and specifics of your home loan, it’s also a good idea to set yourself up as best you can to ace the mortgage application success. “There are three pillars: your credit score, your income (which is converted to a debt-to-income ratio) and your assets,” explains Josh Moffitt, President of Silverton Mortgage in Atlanta. “On the borrower’s side, those are really the three most important things.”
1. Improve your FICO credit score
Your three-digit credit score can be the difference between getting a low rate or being hit with more costly borrowing terms.
“A credit score is always an important factor in determining risk,” Saunders says. “A lender is going to use the score as a benchmark in deciding a person’s ability to repay the debt. The higher the score, the higher the likelihood that the borrower will not default.”
In general, the more confident the lender is in your ability to repay on time, the lower the interest rate they’ll offer.
To improve your score, pay your bills on time and pay down or eliminate those credit card balances. If you must carry a balance, make sure it’s no more than 20 percent to 30 percent of your available credit limit. Also, check your credit score regularly and look for any mistakes. If you find any errors, work to clean them up before applying for a mortgage.
2. Build a record of employment
You’re more attractive to lenders if you can show at least two years of steady employment and earnings, especially from the same employer. Be prepared to show pay stubs and W-2s. It can be more difficult to qualify if you’re self-employed or your pay is coming from multiple part-time jobs.
3. Save up for a down payment
Putting more money down can help you obtain a lower mortgage rate, particularly if you have enough liquid cash to fund a 20 percent down payment. Of course, lenders accept lower down payments, but less than 20 percent usually means you’ll have to pay private mortgage insurance, which can range from .05 percent to 1 percent of the original loan amount annually.
The sooner you can pay down your mortgage to less than 80 percent of the total value of your home, the sooner you can get rid of mortgage insurance, reducing your monthly bill.
4. Consider an adjustable-rate mortgage
Taking out a traditional 30-year fixed-rate mortgage might not make financial sense for all homebuyers. It might save you money if you lock in a lower rate for a shorter period of time, such as five, seven or 10 years. A so-called adjustable-rate mortgage is an option to consider, although you need to be aware that the interest rate could increase after the fixed period ends and the rate readjusts.
“Adjustable-rate mortgages (ARMs) are a financial tool that work for some. They’re really designed as short-term lending products (with interest rates) that will adjust some time in the future, set by the type of ARM it is,” Moffitt explains, adding that buyers typically choose a term from three to 10 years, depending on their needs. “For instance, say [a lender] has a first-time buyer who hopes in five years to get the next job promotion to move or upsize (to a more expensive house). If they know going in that it’s not their forever house, they can save a little money while they’re there because the ARM loans should be at a better rate than the 30-year fixed.”
5. Go for a 15-year fixed-rate mortgage
While 30-year fixed mortgages were once the norm, if you think you’ve found your long-term home and have good cash flow, consider a 15-year fixed-rate mortgage and pay off your house sooner. According to U.S. Bank, the national average for a 15-year mortgage is 4.15 percent. On a $260,000 loan, your monthly payments will be considerably higher ($1,943 vs. $1,264 for a 30-year fixed), but you’ll save more than $100,000 in interest over the life of your loan.
6. Shop among multiple lenders
When searching for the best rate, even for refinancing, do the necessary research to make sure you’re getting the best fit for your situation. Look beyond your bank or credit union, talk to multiple lenders and explore options online. “Shop and compare based on the loan estimates received,” Saunders says. “You wouldn’t normally purchase a car without test driving it first. Test drive your loan before proceeding with your purchase.”
7. Lock in your rate
Sometimes the closing process takes weeks or even months, a period in which rates can fluctuate. After you sign the home purchase agreement and have secured your loan, ask your lender to lock in your rate. The service sometimes comes with a fee, but it might pay for itself if rates rise.
Wondering if rates will go up, down or remain unchanged? See what Bankrate’s panel of mortgage experts predicts.