The fact remains that millions of Americans do not have the required financial power to buy or fix up a home. That’s where getting a mortgage comes into play.
Whether you’re purchasing your first house, fixing an existing property, or are looking to refinance, getting the right mortgage is crucial. A lower mortgage rate equals lower monthly mortgage payments and savings running into thousands of dollars. This article discusses some sure-fire ways you can get the best mortgage rate even as a first-time homebuyer.
- To get a good mortgage rate, you’ll need to have an excellent credit score. So, you must boost your credit score before applying for a mortgage.
- Your down payment plays a role in determining the mortgage rate you could get. Higher down payment may qualify you for a better interest rate due to the lower risk on the lender’s part.
- The type of mortgage and interest rate you qualify for depends on several factors outside your credit score. It is common for lenders to base interest rates on a borrower’s employment history, debt-to-income ratio, and income level.
- The type of mortgage, mortgage amount, loan terms, and property locations may also play a role in the kind of mortgage rate you get from lenders.
If you’re like millions of Americans, buying a home may be one of the most significant financial decisions of your life. And you will most likely need a home loan to fund such a finance-intensive purchase.
What’s the best interest rate for a mortgage?
Mortgage rates fluctuate all the time, and a good mortgage rate today could be completely different from one week to the next. In today’s low-rate environment, interest rates have been hovering around mid to high 2%, and for someone with an excellent credit score, between 3% and 4% is generally a good rate for a mortgage.
Eight Ways to Get the Best Mortgage Rate Even as a First-Time Homebuyer
If your goal is to get the best possible mortgage rates, you’ll’ need to make sure you are well qualified and understand the entire mortgage requirements. Below are some of the key criteria lenders look at when determining the mortgage rate for a potential borrower.
1. Build a Stronger Credit Score
It is no longer news that a good credit score helps you get a better mortgage rate when applying for a home loan. Lenders use the credit score as a benchmark in determining a borrower’s ability to pay back the loan. In other words, the higher the score, the less likely someone would default. On that account, lenders offer individuals with excellent credit scores lower interest rates than those with an average or low score. How high should your credit score be, you might ask? In general, a credit score of 700-740 and above is ideal for lenders to offer you a competitive interest rate.
However, while you may not be able to raise your credit score to this level within a short period, there are several things you can do to get it as high as you can before applying for a mortgage. You can start by paying your credit card debts, correct errors on your credit report, and pay existing due-collection accounts.
2. Save for a Higher Down Payment
Like the average businessperson, lenders hate to take risks, and that’s one reason why lenders prefer 20% or even higher down payment. Borrowers are less likely to default if they have more skin in the game. Putting more money down upfront can help you get a lower mortgage rate, especially if you have enough cash to finance a 20% down payment or more.
While most conventional mortgage lenders may accept down payments lower than the 20% mark, note that you may have to deal with the cost of private mortgage insurance (PMI).
PMIs are typically 0.05 percent to 1 percent of the total loan amount annually. Of course, you will be able to get rid of PMI once your equity reaches 20%. Keep in mind that certain loan types have different down payment minimum requirements, and so be sure to explore all of your options if you prefer to put down less than 20%.
3. Keep Your Income and Employment Stable
You are more likely to receive a great mortgage rate if you can prove to your lender that you have a stable income and employment, especially from the same employer.
It is common for lenders to prefer borrowers with a proven employment record for the last two years. Long periods of unemployment or declining income may not appeal to most lenders. More importantly, lenders may flag your application if you are switching industries with no viable employment offer.
Due to strict lending requirements, you may find it challenging to qualify for a loan if you’re’ self-employed, but it’s’ not impossible. Expect to present lenders with your business records, tax returns, and P&L statement when applying for a mortgage.
4. Lower Your Debt-to-Income Ratio
Also referred to as DTI, your debt-to-income ratio plays a huge role in determining the mortgage rate you get. Typically, the debt-to-income ratio comes in two forms ─ front-end ratio and back-end ratio.
The back-end ratio measures all your total monthly debt payments, proposed mortgage payments divided by your monthly gross income. While the front-end ratio focuses on just your monthly housing expenses, excluding personal debts.
A front-end ratio of 28% and a back-end ratio of 36% is considered ideal for most lenders. However, the type of mortgage and other mortgage factors may cause these numbers to go higher.
For example, loans like FHA require borrowers to have a maximum back-end DTI of 43%. A lower DTI ratio may help you get a lower mortgage rate.
5. Consider an ARM or 15-Year Mortgage
While 30-year loan terms are more popular among borrowers, if you are hoping to get the best mortgage rate, getting an Adjustable-Rate Mortgage (ARM) or 15-year fixed-rate mortgage may help. Shorter loan terms translate to less risk for lenders to endure because they don’t have to lend the money out for so long.
Note that, however, your monthly payments will be higher by getting a shorter loan term mortgage, and with an ARM, you may experience an increase in the rates during the life of the loan.
According to RealtyHop, for instance, the national average mortgage rates on 30-year rate loans were 2.990% as of July 2021, but on 15-year mortgages, they were 2.282%. At the same time, 5/1 ARM stood at 3.725%.
6. Consider Paying Points
If you have extra cash at hand, you can consider paying discount points to your lender. Paying discount points qualifies you for a lower mortgage rate. That’s why discount points are typically referred to as “buying down your rate” in the mortgage community.
By paying one point, which equals 1% of the loan amount, borrowers can typically lower the mortgage interest rate by around 0.25%. For instance, if you take out a $500,000 loan with a 4.5% interest, you can reduce your interest rate to 4.25% by paying $5,000.
Before opting to pay points to your lender, you should first consider your long-term housing plans. You want to make sure you will own the home up to the required break-even point.
Your break-even point is the period whereby your savings from the lowered rates surpasses the cost of points.
7. Check Out First-Time Homebuyer Programs in Your Area
If this is your first time buying a home, take some time to research if you are eligible for any first-time homebuyer programs. Many states set up credits and grants to assist first-time homebuyers and sometimes even repeat buyers.
8. Speak to Multiple Lenders
When shopping for the best mortgage rate, either for a purchase or refinance purpose, do the necessary research to ensure you are getting the best rate peculiar to your situation.
A recent study revealed that borrowers saved $1,500 on average by getting an additional quote and $3,000 on average by getting five.
So, if you are hoping to get the best mortgage rate possible, don’t accept the first quote you received. Talk to multiple lenders and do online research to get the best.
Applying for a mortgage can be pretty challenging, but it is a lot easier when you have your finances in order from the get-go. So, take some steps to work on your credit score, save for a higher down payment, reduce your DTI ratio, and remember to shop around and talk to multiple lenders before you make up your mind.
Elijah O. Agor, CFP
Elijah O. Agor is a real estate, 1031 exchange, and mortgage writer. He is a certified financial planner, former loan originator, and chief realtor for Dsquared Realty. In the past, Elijah advised first-time and seasoned home buyers on real estate and mortgage decisions in the Greater Atlanta area. Since hanging up (burning) his suits and ties, Elijah now works to make mortgage and real estate topics understandable and jargon-free.