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Despite remaining fairly steady in the last few months, mortgage rates are still much higher than homebuyers would like – and according to experts, they’re unlikely to fall substantially until inflation does.
There’s no need to despair, though. A volatile interest-rate environment complicates the equation, no doubt, but buying a home isn’t just about economic trends. It’s important to shop for a home — and a loan — when it suits your financial and life situation. Fortunately, there are ways to set yourself up to get the best possible mortgage rate, even in this high-rate environment.
Your loan’s interest rate depends on many factors, including your down payment, credit score, the appraised value of the home you’re buying and the time period, or term, of your loan. We’ll break down how to shop for the best mortgage rate for your home purchase.
Steps to get the best interest rate on your mortgage
As you consider your options it’s a good idea to set yourself up as best you can to ace the loan application and score the best mortgage rate. “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.
Ready to learn how to get the lowest interest rate on a mortgage? Follow this eight-step process.
1. Improve your credit score
Boosting your credit score is a great first step if you’re wondering how to get a lower mortgage interest rate. A lower credit score won’t automatically bar you from getting a loan, but it can make all the difference between getting the lowest possible rate and being hit with more costly borrowing terms.
“A credit score is always an important factor in determining risk,” says Valerie Saunders, vice president of the National Association of Mortgage Brokers (NAMB). “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.”
To be considered for a conventional mortgage, you’ll generally need a score of 620 or higher. However, the best mortgage rates go to borrowers with the highest credit scores (usually 740 or above). 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 and report regularly and look for any mistakes on your report. If you find any errors, work to clean them up before applying for a mortgage.
2. Build a steady employment record
You’re more attractive to lenders if you can demonstrate at least two years of steady employment and earnings, especially from the same employer. Be prepared to show pay stubs from at least the 30-day period prior to when you apply for your mortgage and W-2s from the past two years. If you earn bonuses or commissions, you’ll need to provide proof of that, as well.
It can be more difficult to qualify if you’re self-employed or your pay is coming from multiple part-time jobs, but not impossible. If you’re self-employed, you might need to furnish business records, such as P&L statements, in addition to tax returns, to round out your application.
What if you’re a graduate just starting your career, or back in the workforce after time away? Lenders can usually verify your employment if you have a formal job offer in hand, so long as the offer includes what you’ll be paid. The same applies if you’re currently employed but have a new job lined up. Lenders might flag your application if you’re switching to a completely new industry, however, so keep that in mind if you’re making a major change.
Gaps in your work history won’t necessarily disqualify you, but how long those gaps are matters. If you were unemployed for a relatively short time due to illness, for instance, you might be able to simply explain the gap to your lender. If you’ve been unemployed for longer, though — six months or more — it can be tough to get approved.
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 costs, on average, between 0.58 percent and 1.86 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.
If you’re a first-time homebuyer and can’t cover a 20 percent down payment, there are specific loans, grants and programs designed to help you purchase a property. Eligibility varies by program, but often are based on things like your income and whether you’re a first-time homebuyer.
4. Understand your debt-to-income ratio
Your debt-to-income (DTI) ratio compares how much money you owe to how much money you make. Specifically, it compares your total monthly debt payments against your gross monthly income. Not sure how to figure out your DTI ratio? Bankrate has a calculator for that.
In general, the lower your DTI ratio, the more appealing you are to lenders. A low DTI means you can likely afford a new loan payment without stretching your budget. The higher your DTI, the more of your income you’re already putting toward your obligations, making affording more debt harder.
A popular rule of thumb for lenders is to avoid mortgages that will require a payment of more than 28 percent of your gross monthly income. Your overall DTI should remain below 36 percent.
So, if you make $5,000 per month, you’ll want a mortgage payment of no more than $1,400 ($5,000 x 0.28) and want to ensure your mortgage payment plus other debt payments remains below $1,800 ($5,000 x 0.36).
The maximum DTI for a conventional loan is 45 percent and the maximum for FHA loans is 43 percent. However, there can be some exceptions if you meet certain requirements, such as having significant savings.
If you’re struggling to get out of debt, there are several techniques that can help you pay it down quicker, including the avalanche and snowball methods.
5. Check out different mortgage loan types and terms
If you think you’ve found your long-term home and have good cash flow, consider a 15-year fixed-rate mortgage, instead of the traditional 30-year fixed-rate mortgage. You’ll pay more each month, but pay off your home sooner — and you’ll pay less in interest, since interest rates on 15-year mortgages fall below other mortgage options’. You can also go for a 15-year term if you’re refinancing your current mortgage.
Alternatively, while rates are high, you might want to consider an adjustable-rate mortgage (ARM). With these types of loans, you’ll start off with a fixed rate for the first stage of your loan (often five or seven years), which is typically lower than what you’d get with a fixed-rate mortgage. After this period expires, the loan switches to an adjustable rate (which means your rate can go up and down) for the remainder of the term. When that happens, or whenever rates fall, you could refinance an ARM loan into a fixed-rate mortgage.
Finally, you can see if you qualify for government-insured or -guaranteed loans, such as:
- FHA loans: Insured by the Federal Housing Administration, FHA loans are popular with first-time homebuyers since the minimum credit score and down payment requirements aren’t as high as they are with conventional loans.
- VA loans: If you or your spouse have served in the military, you could consider a VA loan, which is guaranteed by the U.S. Department of Veterans Affairs. In most cases, there’s no down payment necessary, but your lender might require one if you have a lower credit score.
- USDA loans: Created by the U.S. Department of Agriculture, the USDA loan program is designed to help low- and moderate-income people in rural areas buy a home. Again, there’s no down payment needed, but your home must be in an eligible area, and your income cannot exceed a certain amount (based on your location and household size).
6. Consider paying mortgage points
If you’re willing to pay a fee, you can buy your way to a lower interest rate using mortgage points. Each point costs 1 percent of your mortgage amount and typically reduces your interest rate by 0.25 percent. You can think of mortgage points as a form of prepaid interest.
For example, let’s say that you have a $400,000 home loan with a 7 percent interest rate. If you want a lower rate, you could buy a mortgage point for $4,000 and knock your rate down to 6.75 percent.
However, buying mortgage points isn’t right for everyone. It takes around five years (or more) to recoup the upfront costs, so this strategy isn’t ideal if you plan on selling within a few years.
7. Compare offers from multiple mortgage lenders
When searching for the best mortgage rate, even for a refinance, do the necessary research to make sure you’re getting the best fit for your situation. Don’t accept the first rate you’re quoted — it pays to shop around, a recent Freddie Mac study found. For a $300,000, 30-year mortgage, getting a 6 percent rate instead of a 6.5 percent one, for example, could save you nearly $1,200 a year, and nearly $6,000 over five years.
Check with your own bank or credit union, of course, but go beyond and talk to multiple lenders in person and explore options online. As you get more quotes, you’ll notice that — even if the interest rates are comparable — these lenders’ offers come with different fees, closing costs and private mortgage insurance premiums (to name just a few expenses that can really add up). By shopping around, you’ll have more flexibility to choose the offer with the most favorable terms.
“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.”
8. Lock in your mortgage rate
Sometimes the closing process takes several weeks, during 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 often pays for itself, especially in the current volatile, high-rate environment.
How much could you save with a lower mortgage rate?
You know how to shop around for mortgage rates – but how much could it really save you? Check out the chart below to see how the savings can add up on a $250,000 home loan with a 30-year fixed mortgage.
|Mortgage rate||Monthly mortgage payment*||Overall cost|
|*Includes estimates for property tax and homeowners insurance|
As you can see, even a modest rate reduction could mean thousands more dollars in your pocket over the life of your mortgage. By following the steps above, you’ll be well-positioned to secure the best possible rate and maximize your savings.
Monitoring mortgage rate trends
Mortgage rates change frequently based on a few factors, including inflation and economic conditions. While it’s best not to try and time the market, it can be helpful to keep an eye on mortgage rates if you’re thinking about buying a home soon.
Next steps to close on your mortgage
Now that you know how to get the best mortgage rate, it’s time to choose the best loan offer and rate and apply for the loan. Here is an overview of what you can expect during this process:
- Within three days of applying, you’ll get a loan estimate, which spells out the details of the mortgage. This includes a list of closing costs, but bear in mind these are only estimates at this point, not the final numbers. If you have any questions about what’s in your loan estimate, you can ask your lender for clarification at this time.
- Your lender’s underwriting department will review your application to determine whether to approve your mortgage. During this time, you might be asked to provide more documentation or answer questions, so be prepared and responsive. Maintain your financial and employment situation, too — don’t apply for any new credit cards or loans, make large purchases or switch jobs, if you can help it.
- If your mortgage is approved, you’ll be on your way to closing. If your loan is denied, it’s important to find out what influenced the decision. Generally, you can reapply for another mortgage with another lender as soon as you want to, but it might make sense to wait for a time so you don’t harm your credit.
As you near your closing date, you’ll receive a closing disclosure with the finalized loan terms, including your interest rate, and closing costs. Be sure the rate in this document matches the figures you were originally quoted. Keep in mind rate locks usually only apply for a set period of time, so it’s best to work with your lender to avoid delays on the road to closing.