This article is reprinted by permission from NextAvenue.org.
As a homeowner, your mortgage interest rate determines not only the size of your monthly mortgage payment, but also the total amount you’ll pay over the lifetime of the loan.
Securing a mortgage at the best interest rate possible can save you hundreds of dollars a month and tens of thousands of dollars over the years.
For example, a 30-year-mortgage for $300,000 with a 3.00% fixed interest rate results in an estimated monthly payment of $1,264; over the life of the loan, principal and interest payments will total $455,332, according to Experian EXPGY, -1.57%, a consumer credit reporting company.
If the interest rate for the same mortgage is 5.00%, your monthly payments will increase by more than 25%, to $1,610, and over the lifetime of the loan, you’d pay $579,767 in principal and interest.
But how much leverage do home buyers have over the mortgage rates lenders offer?
“The reality is that much of the rate determination process is driven by policies from Freddie Mac FMCC, -0.08% (the Federal Home Loan Mortgage) and Fannie Mae FNMA, +0.53% (the Federal National Mortgage Association), so there is not a lot of room for negotiating lower rates,” says John Cunnison, chief investment officer at Baker Boyer Bank in Walla Walla, Washington. “But there is some.”
Jason Lerner, vice president and area development manager at George Mason Mortgage, a subsidiary of United Bank, says three factors most often influence mortgage rates. “One is the risk associated with the transaction,” he says, “two is market conditions and three is the lending company and the specific loan officer you work with.”
Fundamentally, lenders weigh the risk of you not repaying the mortgage. The higher the risk, Lerner says, the higher the interest rate will be to offset that risk.
Knowing that, here’s what you need to know and do to get the best mortgage interest rate.
Get an accurate initial quote
You may be quoted an initially low interest rate that is subject to change later. However, you can avoid this unpleasant surprise by making sure the initial quote is as accurate as possible.
“When gathering quotes, the borrower should provide as complete a package as possible to give the potential lender the most accurate picture of their financial situation,” says David A. Krebs, principal broker at DAK Mortgage in Miami. “Reveal any weaknesses upfront, like a low credit score, inconsistent income history, etc. to avoid getting quoted an artificially low interest rate that won’t come to fruition later in the underwriting process.”
Improve your credit score
Your credit score, which is independently calculated by three credit bureaus — Experian, Equifax EFX, -0.50% and TransUnion TRU, -0.13% — helps lenders to quickly assess the risk of lending money to you. Scores range from 300 to 850.
According to Patricia Maguire-Feltch, national sales executive at Chase JPM, +0.58% Home Lending, a high credit score can help to ensure a favorable mortgage interest rate.
“Ultimately, any credit score in the 700s or above is considered good and will help qualify you for lower interest rates,” she says.
Check your credit report
Lenders also consider your credit report, which consolidates information about each of your loans and credit cards, such as how many you have, how much you owe on them and whether you are current with payments.
To make sure the information is accurate, federal law enables consumers to obtain a free copy of their credit report once a year at annualcreditreport.com. Consumers can challenge erroneous information about late payments or other blemishes on their credit histories.
“Although having a high credit score is important, mortgage lenders will often look at a borrower’s full credit report to determine their interest rate,” says Maria Roloff, wealth management adviser with Northwestern Mutual. “A credit report includes a detailed look at credit accounts, credit inquiries, payment history, on-time payments, etc.”
Stable income and employment
Lenders also care where your money comes from. They want to ensure that it’s from a legal source — and it’s a steady, ongoing source of income. So, for example, if you inherit $40,000 from a relative and decide to use it to buy your house — but you don’t have a job or other income source — that windfall will not count for much.
“Lenders want to ensure that a borrower has a stable income to pay back the loan over the next 15 to 30 years,” says Roloff.
Reduce debt-to-income ratio
Your debt relative to your overall income is another factor the lenders will review. A lower ratio of debt to income can lead to a lower interest rate, so it is important to pay down as much debt as possible before applying, says Kortney Ziegler, CEO and founder of WellMoney and a Stanford University Fellow.
So, even if you make a lot of money, a lot of debt could hinder your chances of getting the best interest rate. According to Cunnison, this is another way that lenders access your financial health. “If you are in the market for a house, think carefully about (making) other large purchases, like cars, because you want to have a lower debt-to-income,” he says.
Lower loan amount
The loan-to-value (LTV) ratio — the amount of the loan as a percentage of the home’s value — is another metric that lenders consider. “For most mortgage products, the lower the loan-to-value of the mortgage, the lower the interest rate,” says Lerner. He adds that you can usually get a better interest rate by reducing the loan amount.
So, how could a potential buyer do this? If you have enough cash set aside, you can increase your down payment. “This lowers your LTV, and the lower the LTV, the less risk to the lender, and therefore the lower the interest rate,” Krebs says. “The lender’s price sheet is usually separated into 5% to 10% LTV buckets, so, for example, decreasing the LTV from 75% to 70% will decrease the (interest) rate.”
Taylor Kovar, CEO and founder at Kovar Wealth in Lufkin, Texas, says a hefty down payment is a strong bargaining chip when applying for a mortgage. “Traditionally, a 20% down payment is the golden standard — it not only lowers your loan amount, but also allows you to avoid paying for private mortgage insurance.”
Lenders often require borrowers to buy mortgage insurance when their down payment is less than 20% of a home’s value. Although borrowers pay for the insurance, it protects the lender from losing money if the borrower can’t make payments.
Lock in the best rate
Since your interest rate can change, it’s important to make sure your lender or mortgage broker is keeping an eye on it. If the rate dips, Krebs says you should lock in that lower rate. “Keep in mind that rates can usually be locked for only certain increments — like 30 days or 45 days — so it is important not to lock too soon before the closing date.”
If you lock in an interest rate and then rates decrease significantly, he says you can consider “breaking the lock” to take advantage of lower rates. “But that comes with a ‘break fee’ that might not make the switch worth it,” Krebs warns. So make sure you find out early on how much it would cost to break the lock.
Seek a shorter loan term
Yet another way to get a lower interest rate is to choose a shorter loan term. According to Ziegler, you can usually get a lower interest rate if you choose a 15-year mortgage instead of a 30-year mortgage. That means you will pay less interest overall, but the monthly payments will be higher.
Cunnison agrees that a shorter loan term comes with a lower interest rate, so this may be a viable option if you can afford the higher payments. “However, ensure that you can meet other important obligations if you choose this path,” he says, “because you don’t want to neglect your 401(k), for example, to pay your higher mortgage payment.”
Consider a different type of loan
An adjustable-rate mortgage (ARM) is another way to get a lower rate. “These loans typically offer lower rates than a 15- or 30-year fixed-rate [mortgage], and this can be especially helpful during periods where interest rates are higher,” says Roloff.
The interest rate on ARMs is fixed for a certain time period, and then it can be adjusted up or down depending on interest rates at the time. It is important to know up front how much and how often the interest rate on the mortgage can change. Borrowers often switch to fixed-rate loans when mortgage rates fall.
“Some lenders will even offer refinancing with reduced or no costs within a certain period,” says Roloff.
Look for rewards and benefits
Here’s something you may not have thought of: your bank’s loyalty program. If your bank offers one, enroll in it to maximize financial rewards or benefits.
“Some banks have reward programs in which members are eligible for discounts on various lending products, including a reduction on a mortgage origination fee and interest rate discounts on a new home equity line of credit,” says Matt Vernon, head of retail lending at Bank of America BAC, +1.13%.
Also on MarketWatch: My elderly parents didn’t plan ahead. We’re making some tough decisions.
Pay discount points
Zeigler notes that paying points is another way to get a lower interest rate. “Points are fees paid directly to the lender at closing in exchange for a reduced interest rate,” he says. “This is also called ‘buying down the rate,’ and it can lower your monthly mortgage payments.”
So, how does this work? Vernon says you pay some of the interest up front in exchange for a lower interest rate over the duration of the loan.
“When choosing between a 20% down payment or purchasing points, make sure you run the numbers,” he advises. “A lower down payment can also mean paying for private mortgage insurance, so calculate whether the added expense of this insurance would cancel out any savings from purchasing points.”
And that’s why Lerner says it is important to work with a trustworthy and knowledgeable mortgage professional. “You want to ensure that the points paid are to reduce the rate and not increase the lender’s profitability or compensation,” he says, “and that the borrower will have the mortgage long enough to recoup the upfront expense of the points with the lower monthly payments.”
Terri Williams has over 10 years of experience writing about student loans, mortgages, real estate, budgeting, home improvement and business in general. Her work has appeared in The Economist, TIME, Forbes, Architectural Digest and Realtor.com.
This article is reprinted by permission from NextAvenue.org, ©2023 Twin Cities Public Television, Inc. All rights reserved.
More from Next Avenue: