Your mortgage rate greatly impacts your finances. The smallest of fluctuations can alter your plans in a major way, given that it is multiplied over a large lump that is spread over many years.
These five tips below will help you secure the best mortgage rate possible.
Improve Your Credit Score
A credit score is vital in determining the rate of interest that you receive or whether you get that mortgage in the first place. A credit scores is your report on your creditworthiness, so the best rates are given to people with scores of 740 and above.
There are factors that determine your credit score are multi-faceted. Your payment history accounts for 35%; length of account history 15%; recent credit applications 10%; types of credit 10%; and credit utilization ratio accounts for 30%.
Thankfully, if your credit is in need of improvement there are ways to do so. Start by paying your bills on time. As for your credit accounts, refrain from opening new line within six months of your mortgage application and keep the old accounts open even if you’ve already cleared payment.
Keep in mind that your credit utilization ratio gives the amount of money that you’ve borrowed relative to what you’re enabled to borrow. Keep this lower than 20%. If for example your credit limit is $10,000, let your balance be no more than $2,000.
Improve Your Debt-to-Income Ratio
A lender will look into your “front-end” and “back-end” debt ratios. Front-end ratio shows the percentage of your monthly before tax income that goes toward your mortgage payment. It should be less than 28%.
Your back-end ratio is also called “total debt-to-income.” This shows the proportion of your income that goes toward all debt pay-off. This includes your payments to student loans, car loans, and others. It should be less than 36%. To become an even more enticing borrower, pay down your other debts so that your DTI looks good. As a bonus, this may also improve your credit utilization ratio.
Consider a Short-Term Fixed-Rate Mortgage
Most borrowers only have in mind a fixed rate 30-year mortgage. However, if you make higher monthly payments, you can get an even lower rate by opting for a fixed rate, 15-year mortgage. It offers interest rates as much as 0.8% lower than its 30-year counterpart.
Do not be afraid of a 15-year mortgage without doing your homework. The payments will not be double what your 30-year mortgage would be. Keep in mind that there are four elements to a mortgage: principal, interest, taxes, and insurance. For the last two it doesn’t matter the repayment term of the loan, they remain intact.
Fixed- vs. Adjustable-Rate Mortgages
You can also consider adjustable-rate mortgages (ARMs). These loans are “locked” for the first few years with a fixed cap on how much they can adjust afterward. ARMs can be a good choice if you’re sure you’ll sell while the rate is still locked. But be cautious; during the recession when home values fell, some people with ARMs suddenly owed more than the house was worth.
Bottom line: if you have an ARM, be sure you can cover the higher payment when the loan adjusts suddenly.
Pay for Points
Most lenders collect money upfront in exchange for a lower interest rate. The deals are called “points.” One point is 1% of the borrowed amount, and the more you pay, the lower your interest rate will be. The longer you expect to hold the loan, the more it actually makes sense for you to pay for points. If your plan is to sell the home, refinance or pay off the loan within the next decade, then paying for points is not a necessarily attractive option for you.