In a Nutshell
You can't control every part of your mortgage, but you may be able to score a great interest rate by improving your credit and saving for a big down payment.When you apply for a mortgage, there’s one factor that could save you tens of thousands of dollars if you play it right: your interest rate.
Your interest rate impacts how much you’ll pay your lender over time. Fortunately, you may be able to influence the interest rate you get by taking steps to build your credit, saving for a big down payment and researching your options.
Mortgage experts predict that interest rates will jump by a half percentage point this year, which may seem trivial. But take a closer look: A 30-year, $250,000 mortgage with a 4.25% fixed interest rate will cost about $21,400 less over the life of the loan than the same mortgage with a 4.75% rate.
By being proactive about prepping your finances and researching the best mortgage rate, you can save big time.
Whether you’re planning on refinancing your current abode or purchasing a new home, here’s what you can do to better your chances of scoring a great mortgage rate:
1. Build your credit.
2. Save for a down payment (plus a reserve).
3. Figure out what loan works best for you.
4. Shop at a mix of financial institutions.
1. Build your credit.
When you shop for mortgages, the rates you’re offered will be driven mostly by your credit. You can check your credit with Credit Karma for free, though keep in mind that these are educational scores — mortgage lenders will likely use a different score.
If your score needs work or your report has errors on it, take steps now to build your credit before applying for a mortgage. If you’re able to boost your credit, you could save a lot in interest.
Two of the biggest factors that contribute to your credit scores are whether you consistently pay on time and how much debt you owe.
If you’ve missed a few payments on your credit cards or loans in the last year, focus on paying your bills on time this year.
Next, pay down your debt if you have extra cash.
2. Save for a down payment (plus a reserve).
When taking out a mortgage, you’ll pay a certain percentage of the home’s value upfront. This is called a down payment.
While you may be approved for a mortgage with a down payment of less than 20% (FHA loans allow for down payments as low as 3.5%, for example), a down payment of less than 20% is typically considered more risky to lenders.
On the other hand, a down payment of 20% or more could help improve your mortgage rate. It can also help you avoid having to pay for private mortgage insurance, which protects the lender if you stop making your mortgage payments. Borrowers are typically required to pay for PMI when they get a loan with a down payment that’s less than 20%.
It can be hard to save for a 20% down payment, especially if you’re trying to pay down debt at the same time. After all, a 20% down payment on a $250,000 house is $50,000 — not an amount everyone can easily set aside. If you have the time and availability, you might consider getting a side job to help you save.
In any case, you should carefully consider your overall financial situation before shelling out a large down payment. Lenders generally require that you have at least two months’ worth of cash reserves in your savings account.
3. Figure out what loan works best for you.
Mortgage loans typically come in two forms.
- Conventional loans are not insured or guaranteed by a government agency.
- Government-insured loans are backed by a government agency such as the Federal Housing Administration or Veterans Administration.
Generally, people with lower credit and smaller down payments can qualify for an FHA loan, but they tend to be more expensive than conventional loans. Your loan officer can help determine what type of loan you qualify for and what’s best for your situation.
Rates also typically come in two types.
- Fixed-rate loans lock in your interest rate for the entire loan term, which often range from 10 to 30 years.
- Adjustable-rate loans typically have a fixed interest rate for five, seven or 10 years and then adjust annually after that (based on an index).
Although you may qualify for a low adjustable rate — they’re typically lower than fixed rates by about 1 percentage point — it may increase over time.
The most popular type of adjustable-rate mortgage, or ARM, is the 5/1, where your rate is fixed for five years and then adjusts every year after that. But if you know you’ll be in the home more than five years, it may make more sense to get the fixed rate, which starts a bit higher than the ARM but won’t increase.
You may be able to improve that fixed rate with discount points, which are fees you can pay the lender at closing in exchange for a reduced interest rate. One point costs 1% of the mortgage amount, so if you’re borrowing $160,000 on a 30-year mortgage, then you’ll pay $1,600. One point could lower your rate by about 0.25$.
If you have the money for points, determine whether you’ll be in the home long enough to recoup that upfront fee. On that $160,000 mortgage, if you buy two points and save 0.50% on your rate, then it’ll take you about three years to recoup the cost.
4. Shop at a mix of financial institutions.
Your finances are in order, and you know what type of loan you want. Now it’s time to shop around for a mortgage.
Rates can fluctuate daily and even from hour to hour, so take that into account while shopping. You might want to shop on different days to get a mix of options.
Start with your bank or credit union, as they may offer you a better rate simply for having an existing banking relationship with them. Make sure you’re also checking other credit unions, national banks, and local or regional banks.
From one lender to the next, you may see different promotional rates, fees, interest rates and offers for discount points. Fortunately, lenders must provide you with a standard Loan Estimate, which makes it easier for you to compare loans.
Heads up: Shopping for a mortgage will add a hard inquiry to your credit reports, which may temporarily lower your scores. Try to limit your shopping to a 45-day window, as multiple credit inquiries from mortgage lenders within this time frame may be treated as just one.
Bottom line
You can help influence your mortgage interest rate by putting in some work first. If you build your credit, save for a down payment, choose the right type of mortgage and rate for your situation, and shop around for the best rates, you can have some say in your mortgage payment.
Armed with this information, take a look at your financial situation and determine what you want and create a plan of action to get there. If your credit and savings are in good shape, take the next step and start shopping for mortgage rates.
Calculate your PMI
Get an idea of how much private mortgage insurance you may have to pay if you get a mortgage.