October 14, 2022
10 Things You Can Do to Get the Lowest Mortgage Interest Rate
Interest rates are top of mind as you look to get the best deal on a mortgage. Here’s how to get the best interest rates when you buy a home – before, during, and even after the process.
The decision to buy a home isn’t usually made overnight. As the idea of homeownership starts to take shape in your mind, set yourself up for success by taking these actions before you ever set foot in a lender’s office. The sooner the better – to help get a lower interest rate in the future.
Your credit score is a number based on the information in your credit history. The calculation takes into account several factors including the type and amount of debt you have and your repayment history. The higher your score, the more responsible a lender sees you at handling debt – leading to a better interest rate.
Steps to improve your credit score include:
- Pay your bills on time
- Request copies of your credit report and fix any errors
- Pay down your debt and leave zero balance accounts open
Besides helping with your credit score, lowering debt affects another important element in a lender’s mind: your debt-to-income ratio. Also called DTI, this ratio helps lenders better understand your ability to afford a home based on how much of your income is already used for paying off debt. Strive for a DTI of no more than 43 percent.
To calculate DTI:
- Add up your monthly expenses from loans and credit cards, including your estimated mortgage payment.
- Divide by your gross (pre-tax) income.
- Multiply by 100 to convert to a percentage.
When applying for a home loan, you’ll need to provide proof of income to verify your sources and amounts of earnings. If you have an employer, documentation is pretty straightforward: You’ll simply supply pay stubs and W2s from your employer. If you’re self-employed, you’ll need to supply other documents such as personal and business taxes and profit-and-loss statements.
Here are some quick tips to help:
- Never accept “under the table” cash payments. If it isn’t claimed on your tax return, it can’t be used on a mortgage application.
- Stay in the same line of work for at least two years leading up to a home purchase. Different employers are acceptable, as long as the role or industry is similar.
- Current and consistent income is key. Be prepared to prove your income is verifiable, stable, and likely to continue into the foreseeable future.
Now that you have a strong foundation, it’s time to get into the real home buying process. Here’s how to put the low-interest odds in your favor when you’re ready to buy:
There are more options than ever when it comes to financial institutions offering home loans. As nonprofits with tax breaks, credit unions tend to offer lower rates than their competitors. It’s important for you to shop around and find a lender you’re comfortable with.
If you can afford higher monthly payments, a shorter loan term will save you in the long run. Lower rates are available because the loan is viewed as less risky. Plus, you save years of paying back compounding interest. Consider a 15- or even 10-year fixed mortgage.
One way to put lenders at ease – and lower your interest rate in the process – is to make a large down payment. As a bonus, you’ll avoid a conventional loan’s mortgage insurance premium (PMI) by putting down 20 percent or more.
Another option if you have extra cash on hand is to buy down your mortgage for a lower interest rate. Just be sure to run the numbers to make sure the added cost makes financial sense. You wouldn’t want to pay thousands of dollars upfront only to move the next year and never recoup what you paid.
Government-backed loans from the U.S. Department of Veterans Affairs (VA) and Federal Housing Administration (FHA) can offer competitive interest rates as part of their special mortgage programs. It is worth exploring VA loans and FHA loans if you meet the eligibility requirements.
The uncertainty of an adjustable rate mortgage (ARM) may feel intimidating. But if you’re looking for the lowest rate available, it’s usually found in the initial, set rate period of an ARM. As long as you plan to sell or refinance before the variable rate period begins, you could save substantially.
After you close and you’re sitting in your new home making monthly payments and watching your equity grow, there’s one last thing to keep in mind. Whether you chose an ARM or rates have dropped since closing on your purchase loan, stay open to opportunities to lock in a lower rate through a refinance. A rate-and-term refi usually offers the best interest rates, but you may consider other types of refinances based on your goals when that time comes.