How can you find the cheapest mortgage out there that suits your needs? Here are some top tips.
Mortgage rates play a big part in determining your monthly payments for a home-buying loan as well as the final loan amount. The more favorable your mortgage rate, the lower your interests and monthly payments. Although it takes a bit of work to qualify for better mortgages, this is doable.
Below, we discuss some key factors that lenders consider when determining mortgage rates. We also give you some tips that will help you understand mortgages.
Improve your credit score
Your credit score is a measure of your creditworthiness from the perspective of the lender, and is one of the first things that lenders look for when giving all types of mortgage loans. If you have a higher credit score, it means you are responsible with debt and are therefore less likely to renege on your loan repayments. This improves your chances of securing a better mortgage rate. Credit scores from Vantagescore and Fair Isaac Corp (Fico) fall in the following ranges:
- Bad Credit: Below 650
- Fair Credit: 651-700
- Good Credit: 701-759
- Excellent Credit: 760 and above
The best rates start from 711. At 760, you will access the best mortgage rates. Work on improving your credit score before you approach your bank for a mortgage. The best way to do so is by always paying your bills on time and in full.
Pay a higher down payment
Although it’s difficult to come up with a higher down payment for a house, taking the time to save up a 20% down payment will guarantee you lower interest rates. For example, assuming a purchase price of $250,000 in Illinois, Chicago, you will pay $969 with a 20% down payment as compared to $1,151 with a 5% down payment.
Improve your debt-to-income ratio
Lenders will arrive at your debt-to-income ratio by dividing all your monthly payments by your income. There are different types of inputs when calculating debt to income ratio.
- Front-end ratio only includes your housing costs such as rent, HOA fees and home insurance. You should aim for a front-end ratio that is less than 28%.
- Back-end ratio factors all other loan payments such as car and student loan repayments. Banks favor a back-end ratio that is lower than 36%.
The lower your DTI, the better your chances of getting lower interest rates.
You can calculate your DTI on a mortgage calculator.
Have a steady stream of income
Having a stable job for at least 2 years will factor well into your mortgage application. If you have been unemployed for a long time or show an unstable pattern of monthly earnings, lenders will view you as a risk. Lenders are also stricter when lending to self-employed borrowers. If you are self-employed, your bank will ask you to fill in IRS form 4506, which will authorize them to receive and verify your tax returns.
Build your cash reserves
Before closing on a mortgage, your lender will want to see your cash reserves. You should, at a minimum, have enough money to make mortgage repayments for a 2-month period. This period may be longer if your lender considers you a higher risk. Note that your retirement fund does not qualify as you can only access it after taxes and penalties are factored in.
Consider how long you intend to stay in the house
Adjustable rate mortgages are just that: mortgages whose interest is adjustable. The initial rate is lower and it increases over the mortgage period. As such, adjustable rate mortgages are more suitable if you don’t intend to stay in your home for the long term, because you get to take advantage of the initial lower rates and sell as the rates begin to rise.
Compare different types of loans
Comparing loans will help you to find the one that will give the lowest interest rates based on the amount you want to borrow and how long the mortgages are. For example, a 30-year fixed mortgage is affordable because of the length of time it takes to pay off. However, 30-year FRM has higher interest rates than the 15-year FRM. If you want a refinance, or a mortgage of a lower amount, for instance, a 15-year mortgage would make sense.
On the other hand, a 5/1 ARM is preferable to a 30-year fixed, if you only intend to stay in a house for a few years. According to Freddiemac mortgage survey data, 5/1 ARMs are lower than a 30-year fixed rate mortgage.
There are plenty of loans out there, such as those from J.G. Wentworth, Lending Tree, Magnolia Bank, NBKC Bank and New American Funding.
Lock your interest rate
If you are happy with the rate that your loan officer quotes, you need to lock it. Rate lock periods range from 90 days to 150 days and they give you a guarantee that during that time, the rate that was quoted for you will not change if rates rise. If rates drop however, you can only take advantage of this with a float down option.
Another way to lock your interest rate is with a preapproved mortgage. A preapproval locks your terms and helps you to shop faster.
Conclusion
Find out about current mortgage rates, and consider every option your lender recommends before making a decision. For instance, mortgages with no closing costs may not be suitable for other people but may be suitable for you. Do your research and only sign contracts once you know your choice of mortgage will give you the best interest rates.
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