There are many factors that go into a mortgage that can significantly increase or decrease the total cost over the life of your loan. These 12 tips help you become a more educated consumer to help reduce your costs.

How To Get The Best Mortgage Rate: 12 Tips To Save You Money

What if you could save thousands of dollars over the life of your home loan? The interest rate you secure when obtaining a mortgage significantly affects your monthly payments and the total amount you'll pay over the duration of the loan. The lower the interest rate, the more money you’ll save.

While you can’t control interest rates, there are several steps you can take to position yourself to get a lower rate. Buying a home is most likely the largest financial decision most people will make in their lifetimes. Even a small drop in the interest rate you pay can save significant money over the long run.

Want to know how to get the best mortgage rate? Here are 12 steps you can take to help.

1. Know Your Credit Score And What It Means

The better your credit score, the better mortgage rate and larger the loan amount you’ll likely be able to get. That’s because lenders use credit scores to help them determine risk and predict the ability of a borrower to repay the loan.

You can start by looking up your credit score and reviewing your credit report. If there are any errors, you can work with the credit bureaus to get them removed from your credit report. You can access free credit reports from all three major credit reporting bureaus at AnnualCreditReport.com. These reports are typically available for free once per calendar year.

You typically need a score of 620 or higher to be considered for a conventional mortgage. While different mortgage lenders have different requirements, borrowers at the higher end of the “excellent” category (740 and above) will usually receive the lowest mortgage rates. Here’s how mortgage lenders view credit scores:

• 720 – 850 considered “excellent”
• 690 – 719 considered “good”
• 630 – 689 considered “fair”
• 300 – 629 considered “bad”

If you have a lower credit score, you’ll likely have higher borrowing costs, but that doesn’t mean you can’t get a loan or there aren’t other types of mortgages for owning a home. An FHA, VA, or USDA loan might be an option if you qualify. It’s also a good idea to work on improving your credit before applying for a loan. You won’t qualify for the lowest mortgage rate, but you can still get a lower mortgage rate by moving into a higher credit tier.

2. Work To Improve Your Credit Score

Once you know your score and have reviewed your report, you can work to improve your credit score by paying off credit card balances and other personal debts to the best of your ability. That will reduce the amount of credit you’re using. Additionally, settle any debts that have been sent to collections and ensure your credit cards remain open to keep your credit utilization rate from rising. Credit utilization is how much of your available credit you’re using at a given time. You should try to use no more than 30% your total available credit.

3. Establish A Consistent Employment Record

Mortgage lenders generally like to see at least two years of steady employment and earnings when you apply for a home loan. In addition to your credit score, steady employment helps assure them you can afford your mortgage payments and will be able to repay the loan over time.

To prove your employment status, you’ll probably need to show pay stubs from at least the 30-day period before completing a mortgage application and W-2s from the past two years. If bonuses or commissions are part of your compensation, you’ll also need to show proof of those earnings.

If you’re self-employed or your pay comes from multiple part-time jobs, there will likely be more steps and it could be a little more challenging to qualify for the best rate, but it’s not impossible. You might have to show tax returns and business records, like profit-and-loss statements.

4. Save For A Down Payment

The larger down payment you make, the better the chance of a lower interest rate. If you pay more initially, you’ll need to borrow less, which will decrease both your monthly mortgage payments and the total interest you pay over time. If you can save for a down payment of 20% on a conventional mortgage, you’ll also avoid the added expense of having to pay private mortgage insurance (PMI). Lenders generally provide better rates with higher down payments because it means there is more equity in the home and less risk for them.

You don’t have to put 20% down with a conventional mortgage, but you will have to pay PMI and likely a higher interest rate. There are programs with no down payment options (VA and USDA loans) and FHA loans requiring only 3.5% down.

5. Avoid Major Purchases

When you're considering purchasing a home, it's usually best to avoid making any big purchases outside of your regular spending habits. These can include buying a car, boat, furniture, or costly appliances. Buying something expensive before closing could affect your credit score and your debt-to-income (DTI) ratio.

Both of these could impact your ability to qualify for the best mortgage rates and could even put your mortgage approval at risk. Paying cash for a large purchase could also impact your loan application because you’ll have lower cash reserves.

6. Calculate Your Debt-To-Income Ratio

In addition to your credit score and the other factors mentioned above, your debt-to-income (DTI) ratio is another important number when you’re trying to figure out how to get the best mortgage rate. Mortgage lenders use your DTI to compare how much money you owe to how much money you make. A DTI at or below 43% is what most mortgage lenders prefer. They see a higher ratio as being more risky because it means there’s less money left to make a mortgage payment after other monthly debt is paid.

To calculate your debt-to-income ratio, divide your total debt by your pretax (gross) income. Total debt includes things like rent, mortgage, credit cards, auto and student loans, or other debt. As an example, if your monthly debt payments are $2,000 and your gross monthly income is $5,000, your DTI is 40% (mathematical breakdown - $2,000 divided by $5,000, then multiplied by 100, resulting in 40%).

There are some ways you can pay down your debt-to-income ratio so it doesn’t stop you from getting the best mortgage rate. You can:

• Pay off or consolidate existing debt
• Find a cosigner – the income of a parent, friend, or relative who cosigns on a mortgage with you can be used to lower your DTI ratio
• Increase your income by taking a second job or a higher-paying full-time job before you start house hunting

You should also remain in a salaried position and avoid switching to self-employment or a commission-based job for several months before applying for and finalizing a mortgage loan.

7. Buy Discount Points

You can reduce the interest rate on your mortgage by paying discount points. These are a one-time fee paid upfront, which is essentially prepaying some of the interest on your loan. One point usually costs 1% of the total loan amount, which lowers the interest rate by 0.25% (but the total reduction can vary). As an example, a single point is $3,000 on a loan amount of $300,000. Recovering the upfront cost can take five or more years, so it’s important to determine if buying discount points will be best over time. It probably won’t be if there’s a chance you could move in a few years or if you plan to refinance.

8. Choose A Shorter Loan Term

You can choose a shorter loan term, with 15-year mortgages often having lower interest rates than 30-year mortgages. Because the home loan is half the length, monthly payments will be a decent amount higher. The advantages are that you’ll pay off your loan faster, build equity faster, and save significant money in interest over the life of the loan. You can use our mortgage calculator to estimate monthly mortgage payments with different loan terms.

9. Consider An Adjustable-Rate Mortgage

The opposite of a fixed-rate mortgage, an adjustable-rate mortgage (ARM) usually has a lower introductory interest rate that results in lower initial monthly payments. After a certain timeframe – typically five, seven, or 10 years – the rate changes (adjusts) every six months or every year based on the market interest rate at the time.

As an example, a 5/1 ARM would have an initial rate fixed for the first five years that would then adjust every one year. The benefit of an ARM is a lower initial rate, but it can be riskier if rates go up, which would lead to a higher monthly payment. If you plan on selling your home or refinancing before the rate adjusts, an ARM could be a smart financial move.

10. Check Out Other Loan Types

Other government-backed loan options may offer better interest rates, as long as you meet the qualification criteria. These options include:

• FHA Loans: Insured by the Federal Housing Administration (FHA), FHA loans can have lower rates and lower minimum credit score and down payment requirements than conventional mortgages. However, they require you to pay mortgage insurance and an annual mortgage insurance premium.
• VA Loans: Backed by the U.S. Department of Veterans Affairs (VA), if you or a spouse served in the military, you could be eligible for a VA loan. Most of these loan types don’t require a down payment and credit score requirements are lower.
• USDA Loans: Guaranteed by the U.S. Department of Agriculture, USDA loans are to help people in rural areas with low-to-moderate income buy a home with no down payment requirements.

11. Lock In Your Mortgage Rate

Since closing won't occur immediately after you sign the purchase agreement and secure your loan, you can lock in your interest rate to prevent changes during this period—especially considering the current rate volatility. Locking in a rate could come with a fee, but it can pay for itself while easing any rate anxiety.

12. Ask Your Lender About Other Ways To Save

Be sure to ask about any possible discounts, credits, or programs that could reduce costs. Some state and local governments offer down-payment assistance or mortgages at a lower rate for first-time homebuyers. You can check out what’s available in your area through the Department of Housing and Urban Development website.

While getting the best rate is the goal, look at everything that’s included in the offer from a lender. Fees, closing costs, private mortgage insurance, prepayment penalties, and other costs can all add to the overall cost of your home loan.

How Much Impact Can A Lower Rate Have?

Now that you know how to get the best mortgage rate, do you know how much doing so could actually save you? Here’s a chart that shows how much the savings could be on a $350,000 home loan with a 30-year fixed mortgage. The figures shown are for the principal and interest only, and don’t include property taxes, homeowners insurance, or mortgage insurance.

As you’ll see, even a small difference in the interest rate can reduce monthly payments and make a big impact on the interest paid over the life of the loan. Just a drop of half a percent (from 7.4% to 6.9%) can save more than $42,000 in total interest paid and reduce monthly principal and interest payments by $118 each month.

Contact us today to learn more about how to get the best mortgage rate to help you save thousands of dollars on your home loan.

Union Home Mortgage Corp. does not provide tax, legal, credit repair, or accounting services. The information provided is generally true but may not apply to you or your situation. For tax or legal advice please consult an appropriate professional in one of these fields. The information provided here is for informational purposes. When interest rates and loan program information are included, it is for illustration purposes only and not a solicitation or quote for services. This is not an advertisement or loan estimate. Current interest rates, loan programs and qualification criteria can change at any time. If you have questions or need assistance, we can be reached using the contact information above.