Buying a home is the most significant purchase in the life of many people. Hence, you may wonder how to get the best interest rate on mortgage, which is not easy to resolve. Plus, if you’re unfamiliar with the available financing options, you can end up paying far more than the average cost.
Curbing your homeownership costs starts with the interest rate attached to your mortgage. The lower figure you can win, the less money you’ll pay over the loan life. Below we’ve selected practical suggestions to lower your mortgage rate. Keep the ball rolling and take one step at a time!
Table of Contents
- 1 How Are Mortgage Rates Determined?
- 2 Getting The Best Possible Mortgage Rate
- 2.1 Know Your Debt-To-Income Ratio
- 2.2 Keep A Steady Income
- 2.3 Increase Your Credit Score
- 2.4 Have A Strong Down Payment
- 2.5 Look For A First-Time Homebuyer Program
- 2.6 Compare Loan Offers
- 2.7 Consider Paying Points
- 2.8 Fixed Or Adjustable Mortgage Rates?
- 2.9 Know Your Closing Costs
- 2.10 Consider Private Mortgage Insurance
- 2.11 Use A Mortgage Calculator To Get Best Interest Rates
- 2.12 Refinancing
- 3 Final Thoughts
- 4 FAQ
How Are Mortgage Rates Determined?
Mortgage rates specify how much interest accrues on your home loan. The higher rate you agree upon, the more money you’ll pay for your house. Though many understand what goes into calculating rates, determining the magic number can be challenging.
So, how low should the interest rate be to qualify as “good”? Unfortunately, the answer isn’t always straightforward. Several market-based and personal factors impact and shape your mortgage rate. None of these aspects can get removed from the process since they’re all vital for a competitive loan offer.
On the market side, the most significant influence stems from the bond market, where residential mortgages get traded. Second, rates fall when the economy slows down, inflation drops, and unemployment rises. Meaning, any recession is a decisive factor when it comes to affordable home loans. Conversely, job growth and rising inflation mean the dollar value is growing, so interest goes up.
In addition, your financial situation can play an essential role. Here, your credit score directly impacts the rates you get, and the best ones go to scores above 740. Next, keeping your down payment or level of existing equity above 20% will boost your odds of getting reasonable terms. Finally, how you plan to occupy the property and for how long will set the final cost.
Overall, mortgage rates vary across lenders since they have different appetites for risk and charge various overhead costs. Often, when creditors reach their potential to process loan applications and serve clients, they keep rates slightly higher. Or, when business is slow, the lender might lower the rates to drum up business.
Getting The Best Possible Mortgage Rate
If you wonder what is the best interest rate for a mortgage, remember they come in all shapes and sizes. Plus, rates vary widely from lender to lender. In short, the interest you get is the price you’ll pay for borrowing money. So even a slight difference can have a drastic impact on the overall cost.
For example, if you take a 30-year, $200,000 fixed-rate home loan with a 3% interest rate, your monthly payment will be $843. Meaning, you’ll pay $103,480 in interest over the loan life. Conversely, it’ll cost you $1,074 per month ($186,512 in interest) for the same loan with a 5% interest rate.
This 2% difference adds up to nearly $83,000 in interest charges over the loan term. You can make similar comparisons depending on the loan term. Also, when you shop around, ensure you’re getting the best available rates. Here are twelve tips to help you choose and save on your mortgage in the long run.
Know Your Debt-To-Income Ratio
Above all, lenders focus on how much debt you carry on your gross monthly income. To determine your DTI and mortgage rate, lenders check your employment and income history. In short, they evaluate your housing ratio and your total debt to set the debt-to-income formula.
The first parameter combines monthly housing costs such as mortgage payment, property taxes, fees, and homeowner’s insurance. Then, this amount gets divided by your gross monthly income. The total debt combines all monthly installments (plus the proposed mortgage payment) and credit cards, car loans, or student loans you might have. This sum also gets divided by your gross monthly income.
Lenders believe that the higher your DTI ratio, the more likely you will default on a loan. Generally, lenders want to see a housing ratio below 28% and a maximum total debt of 36%. Some loan products, like FHA loans, allow borrowers to have a higher DTI ratio of 43%.
Applicants who show proof of their income for a full-documentation loan can get more competitive rates. The terms are less favorable for self-employed borrowers that apply for a no-documentation loan or stated income loan.
Keep A Steady Income
Creditors see you as a more attractive customer if you’ve been in steady employment for at least two years. Working with the same employer is another advantage. When applying, present pay stubs from the previous month and W-2s from the past two years. Also, provide evidence of bonuses or commissions to earn better rates.
Your eligibility can get questioned if you’re self-employed or have multiple part-time jobs. If you’re self-employed, you’ll need to submit more extensive documentation to support your application. It’s best to prepare all business records, such as P&L statements and tax returns, well ahead.
Graduates starting a career can also qualify, but requirements may be more stringent. In this case, lenders verify any formal job offer you might have in hand if it includes your earnings. The same is valid if you’re employed but have a new job lined up.
Gaps in work history and frequent job (even industry) changes won’t necessarily disqualify you, but matter. Most creditors will understand if you were unemployed for a short time due to illness. Yet, it can be tough to get approval if you’ve been unemployed for over six months.
Your debt to income ratio, income, and credit score are among the things you should work on if you want to get the best mortgage rate possible.
Increase Your Credit Score
Many speculate about how to get the best interest rate on a mortgage but disregard credit scores. Not taking your credit score into account when shopping for home loans is a cardinal mistake. In most cases, the rates you get mostly depend on your credit. You can check your score and get a free report at the Annual Credit Report website.
If your score needs improvement or your report contains errors, work on boosting your credit or eliminating deficiencies before getting a mortgage. If you manage to increase your score, this will save a lot in interest. For instance, raising your score from 660 to 760 may save anywhere from 0.5 to 1% on the mortgage rate.
The most significant factors are whether you pay bills and installments on time and your debt level. If you’ve skipped a few payments on your loans, focus on paying on time this year. Mortgage lenders won’t bother to go years back in time to check your payments. What matters are your lending and payment habits in the previous year.
Next, pay down any debt you owe if you have extra cash. Try the “debt snowball” strategy by first paying off your smallest debt and making the minimum payments on other loans. Then, use the money from the settled debt to pay extra on the next-smallest debt, and so on. As a result, you free up more immediate cash in your budget and improve your credit.
Have A Strong Down Payment
The golden rule says the higher your down payment, the better rates you’ll get. So when you pay a small amount upfront, lenders consider you a higher-risk borrower. If this is the case, you’ll have to resort to private mortgage insurance to offset the risk.
If you inject less than 20% when taking out a loan, you’ll have to pay PMI premiums. These premiums will increase your monthly payment and total borrowing costs until you have enough equity to cancel them. Hence, saving up for a more significant down payment will waive PMI altogether and get you a lower interest rate.
Moreover, rural borrowers and veterans may be eligible for loans with 100% financing and no down payment. Others may qualify for mortgages that allow down payments as small as 3%. Here’s a summary of available options:
- VA loans – If you are active military or a veteran, the Department of Veterans Affairs can guarantee a mortgage for you.
- FHA loans – Any mortgage backed by the Federal Housing Administration will allow down payments as low as 3.5%. FHA-insured loans accept low credit scores, but you must pay for mortgage insurance during the loan life.
- USDA loans – The Department of Agriculture might grant a low- or no-down-payment mortgage for rural area residents.
- 3% down loans – Some borrowers may qualify for traditional loans not insured by the government. The mortgages are usually for first-time or low- to moderate-income borrowers. These loans charge for PMI, which can get canceled after you have 20% in equity.
Look For A First-Time Homebuyer Program
Grants and loan programs for first-time homebuyers are available in almost all states. These programs provide many perks such as no down payment, grants, zero-interest, and deferred payment loans. Hence, before you settle on a mortgage, check your eligibility for these special home-buying offers.
Each state offers a different program mix for homebuyers. You can get down payment assistance combined with favorable rates and tax breaks. Some programs depend on the area you live in, while others help certain professions, such as veterans, teachers, and first responders.
In addition, some municipalities offer first-time homebuyer grants to attract new residents. The aid consists of grants or low-interest loans with deferred repayment. So it’s your responsibility to check your state’s housing authority website for more information. Or contact the local HUD-approved housing counseling agency to learn more about first-time homebuyer loans.
The different ways you can benefit from these programs are listed below:
- Grants – Money to put towards home-related costs such as down payment or closing costs.
- Closing fees assistance – Some loans have a cap on how much you’ll pay for closing costs.
- Deferred payments – No interest until the homeowner sells the house or pays off the mortgage.
- Savings on interest – Subsidized interest or help in the form of lower interest rates.
- Loan forgiveness – Homeowners living in the home for a set period will have a part of their debt cancelled.
- Down payment assistance – Some programs allow a small down payment or none at all.
Compare Loan Offers
Once you compare available loans, you’ll stop asking, “What is the best interest rate for a mortgage?” To this end, you must distinguish between conventional loans and government-insured loans. There’s no guarantee for the first loan type, while the second comes from government agencies.
Also, comparison shopping will help you understand the available products and their features. You’ll manage to differentiate between adjustable-rate and fixed-rate rates. Finally, you’ll get to know the prices at which those products are selling, including ancillary services.
One of the best strategies to weigh up mortgages is to apply with multiple lenders at the same time. The more you shop around, the more you’ll save since different lenders offer different mortgage rates. Consider applying with various creditors, such as banks, credit unions and online lenders, to compare their offers.
Next, shop for loans within a set timeframe. The three major credit bureaus encourage you to collate rates. You have up to 45 days, depending on the scoring model, to apply for several mortgages. The effect on your credit scores will be the same as applying for a single loan.
Finally, each lender must provide a Loan Estimate form with details of the loan’s terms and fees. This estimate aims to simplify the task of comparing mortgage offers. As a result, your lender can inform you of the loan types you are eligible for, and best fit your situation. Or you can check applicable rates with an online loan comparison calculator.
Getting your first home is a significant step, and you should prepare carefully before applying for your first mortgage. Even the slightest difference in the interest rate can cost you thousands of dollars over the years.
Consider Paying Points
Most lenders allow homebuyers to pay points at mortgage closing in exchange for a lower interest rate. Meaning, you’re paying a fee, also referred to as a discount, mortgage points, or prepaid interest.
One point is generally 1% of the loan amount (e.g., on a $100,000 loan, a single point is worth $1,000). You can usually purchase points in increments down to 0.125. Still, the amount each point reduces your rate depends on the lender.
Purchasing a single point can drop your current interest rate from 0.125% to 0.25%. For example, a $250,000 loan may cost an additional $2,500, but it will reduce the interest rate by 0.125% over the loan term. It’s up to you to determine whether points can save you money. Typically, lowering your mortgage rate will save money over long-term repayment periods.
If you have extra money to buy points upfront, ensure you’ll be in the home long enough to recoup the investment. For instance, if you buy two points and save 0.50% on your $160,000 mortgage rate, it’ll take three years to recoup the cost.
Getting the discount up front means you’ll shell out thousands of dollars to save a few dollars every month. Often, it can take several years for the monthly savings to exceed the initial amount paid. The break-even period depends on the loan amount, the points cost and the interest rate. So, if you don’t plan to keep the loan or your home for several years, it’s best to skip the discount points.
Fixed Or Adjustable Mortgage Rates?
Mortgage rates are either fixed or adjustable. Choosing the right one will help you decide how to get the best interest rate on the mortgage. More specifically, fixed-rate mortgages lock a consistent interest rate you’ll pay over the loan term. However, insurance, property taxes and other costs may fluctuate.
Interest rates on adjustable-rate mortgages can change over time. Such rates usually begin with an introductory period of ten, seven, five or three years, when the interest rate remains steady. The key to knowing how an ARM resets is in the name. For example, a 5/1 ARM means you get a fixed rate for five years only. After that, the rate can alter and adjust at different intervals.
To attract more buyers, ARMs offer lower introductory rates. But that rate will go up, causing monthly mortgage payments to increase substantially. In rare cases, ARM can decrease and improve your financial position.
What rate you’ll choose depends on your finances at the moment and your short and long-term goals. Adjustable-rate mortgages can be a powerful tool if you plan to keep the house or loan for a short period. Or you can consider a 15-year fixed-rate mortgage to pay off your home sooner.
Know Your Closing Costs
Homebuyers pay the closing costs to the lender and third parties when they close or finalize the purchase. So unless you pay discount points, such fees won’t influence the mortgage rate but your pocketbook only. Overall, expect to pay about 3% of your home’s purchase price.
Closing costs include various fees such as title insurance, the lender’s underwriting and processing charges, and appraisal fees. These expenses help the lender evaluate the home you’re buying, process and finalize your home loan. The most common closing costs are as follows:
- Application fee – This charge enables lenders to defray the cost of loan processing. Though mostly fixed, not all creditors charge an application fee. Hence, it’s worth comparing offers to find the best combination of reasonable costs and a low interest rate.
- Loan origination fee – This charge isn’t mandatory with all lenders and can often be negotiable.
- Points – As discussed above, discount points are optional fees you can choose to pay to reduce a loan’s interest rate.
Finally, your closing expenses can be part of the mortgage, known as no closing cost mortgages. In this case, the lender pays your closing costs and imposes a higher interest rate or adds the fees to your loan amount. In this case, you’ll avoid paying more upfront at loan closing besides your down payment. On the downside, your monthly payment and the overall cost of your home loan will be higher.
Consider Private Mortgage Insurance
Besides closing charges, which are a one-time hit, there’s another catch that concerns many homebuyers. If your down payment is below 20%, you will have to purchase private mortgage insurance. This way, you’re a safer bet for the lender.
The downside of PMI is that you’re the one paying for about 0.5% to 1.5% of the entire loan per year. In short, you add thousands of dollars on top of other loan-related costs. If you end up paying for PMI, ensure you cancel it once you’ve gained enough equity in your house.
The cost of PMI depends on several factors, including:
- The size of the mortgage. The more money you borrow, the more you’ll pay for private mortgage insurance.
- Down payment. The more funds you invest for the home upfront, the less you’ll pay for PMI.
- Your credit score. You’ll pay less for PMI if you have a higher credit score. Generally, you’ll get the best PMI rates for a credit score of 760 or above.
- Mortgage type. PMI usually costs more for adjustable-rate mortgages. The rates can go up, and the risk is higher than with a fixed-rate loan.
Estimating the cost of PMI before borrowing can help you determine the home you can afford. Typically, the premium goes on top of your monthly mortgage payment. In some cases, lenders offer to pay the PMI cost in one upfront or monthly premiums in exchange for higher interest rates.
Use A Mortgage Calculator To Get Best Interest Rates
What is the best interest rate for a mortgage is not an easy question to tackle. Fortunately, you can use a reliable mortgage calculator to help you get insight into the probable monthly payments based on the inputs you provide.
It’s advisable to try out different scenarios to locate the optimal mortgage with affordable monthly payments. The calculator will provide data on the total interest costs, too. For example, you might realize that if you make a larger down payment, you may swing higher payments with a 15-year home loan. To use a mortgage calculator, enter the essential details about the loan, including:
- Home price. The price at which you buy the home.
- Loan term. The period during which you have to repay the loan.
- Down payment. The money you pay upfront to buy a home.
- APR (interest rate). The cost to take out the loan.
- Property taxes. The annual tax levied by your city or municipality as a property owner.
- Homeowners insurance. Your annual cost to insure your place and assets against theft, fire, and natural disasters.
- HOA fees. The monthly charge you pay to your homeowners’ association to cover the costs of maintaining and improving the properties within its framework.
You can change the variables to see how they affect your monthly payment, interest, and total loan cost. For example, if you choose a 10-year loan term, your payments will be higher, but you’ll pay less in interest. Conversely, you can decide to pay less each month, but your interest rate will be higher.
Before you commit, consider why you want to refinance your home loan and how to get the best interest rate for a mortgage. The following are some of the underlying reasons why people choose to refinance:
- Reduce monthly payments. When your ultimate aim is to pay less every month, you can refinance into a loan with a lower interest rate. Besides, you can always extend the loan term from 15 to 30 years to lower installments. The setback to expanding the set period is that lenders will charge you more interest in the long run.
- Pay off faster. When you refinance from a 30 into a 15-year home loan, you settle your debt in half the time. Hence, you open a way to pay less interest over the loan life. One drawback is that the monthly payments will grow, often beyond your financial potential.
- Change the adjustable-rate loan into a fixed-rate one. In most cases, interest on adjustable-rate mortgages will go up after the set period expires. Fixed-rate loans stay the same. If you prefer steady payments, refinancing from an ARM to a fixed-rate loan can provide monetary stability.
- Tap into equity. Your lender will issue a check for the difference if you refinance to borrow more than you owe on the current loan. Most people consider cash-outs to refinance and lock in a lower interest rate.
- Get rid of FHA mortgage insurance. PMI on conventional home loans can get canceled, but the process becomes more complicated with FHA mortgage insurance premiums. The easiest way to waive these is to sell your place or refinance the loan when accumulated enough equity.
You can have an impact on your mortgage interest rate by putting in some work first. Start by saving for a down payment, boosting your credit, and choosing the right mortgage rate for your situation. Armed with the detailed information above, it’s up to you to determine what you want and create an action plan to get there.
Have you recently taken out a home loan? Did you manage to achieve an affordable rate? What methods did you use? Share your thoughts with our loyal readership, and sign up for our newsletter for more budget-friendly tips.
Is 3% a good interest rate for a mortgage?
For the past few years, mortgage rates have remained historically low or around 3% to 4% for a 30-year fixed-rate mortgage. Right now, an interest rate of about 4% is acceptable. Remember that the difference between a 660 and 760 credit score would save you from 0.5 to 1% on rates.
What is the lowest mortgage rate ever?
After 1971, 2016 held the lowest annual mortgage rate of all times or only 3.65%. Note that mortgage rates dropped even lower in 2012 and stood at 3.65% over one week in November. Then rates went up, and the entire year averaged at 3.66% for a 30-year mortgage.
How do I get my lender to lower my interest rate?
Maintain a good credit score and have a long and consistent work history. Then, ask your bank or lender for a better rate. Or put more money down and shorten your loan term. Finally, you can consider adjustable vs fixed-rate mortgages and purchase points.
Can my lender change my interest rate?
Lenders have the right to modify some costs under specific circumstances. So if you haven’t locked your interest rate, it can change at any time. Sometimes, rates can go up or down even if you take a fixed-rate mortgage due to adjusting application information or refinancing.