| How to Get Low Mortgage Interest Rates |
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Getting a low interest rate on your mortgage can save you thousands and perhaps tens of thousands of dollars. In this article, we outline what you need to do in order to get low mortgage interest rates on a new home purchase or a refinance.
Low Mortgage Interest Rates are Currently Available
The timing couldn't be better for getting a mortgage than today. Mortgage rates are at or near all-time lows due to aggressive actions from the Federal Reserve. The Federal Reserve indirectly controls the general level of interest rates by raising or lowering the fed funds (or short term) rate. As a result of the economic crisis, the Federal Reserve has slashed the fed funds rate to zero and is is also purchasing long-term treasury and mortgage securities in an effort to restart the housing market. What does this mean for you? Low Mortgage Interest Rates!
Know Your Credit Score
If you want to qualify for a low mortgage rate, it's important that you know your credit score. Three major credit bureaus -- Experian, TransUnion, and Equifax -- collect the information that makes up your credit history. This information is used to formulate your credit score. The most widely used credit score is called the FICO, based on a model devised by Fair Isaac Corp., which assesses your risk to lenders on a scale of 300 to 850. The higher the score, the lower your mortgage rate.
Don't know your credit score? You can use the following services: MyFICO, Equifax, and PrivacyMatters that will provide you with a complete report and more. MyFICO is perhaps the most well known and will provide you with 2 Equifax credit reports and updates via email if your credit score changes. For 3-in-1 credit reports, you can use Equifax or PrivacyMatters.
In the wake of the subprime mortgage crisis, mortgage lenders have returned to more traditional lending standards. Today, to qualify for the best rates, you need a credit score of above 700. If you don't have a great credit score, don't worry, there are a couple of things you can do improve it.
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Pay Bills on Time
- Should go without saying. Your credit score is a direct reflection of your ability to meet scheduled payments on time, bills are an important piece of this. Pay down any balances owed to bill collectors as well.
Pay Down Credit Card Debt
- Outstanding credit card balances will reduce your credit score. Pay off credit cards if possible.
Don't Take Out New Credit Cards
- Having multiple credit cards lowers your credit score. You should have around 3 credit cards in order to establish credit history, but any number of cards above that will tend to have an adverse affect on your credit score. Close unused credit card accounts such as those from department and electronics stores, as they are only hurting your credit score.
What Loan Size Do You Need?
The rate you receive on your mortgage is dependent on the loan size that you require. The lowest rates are reserved for traditional Fannie Mae or Freddie Mac "conforming" loans, which are for $417,000 or less. The next step up would be a "extended conforming" loan of as much as $729,750, available in the most expensive counties in the United States and costing anywhere from a quarter-point to a full percentage point more. If you need a "jumbo" loan, rates are considerably higher, for people in high-cost counties that borrow more than $729,750, you are likely to pay upwards of 6% -- even if your credit is perfect.
Type of Mortgage: Fixed vs. Adjustable
When deciding to get a mortgage, you will be faced with a variety of options. The biggest decision will be whether to get a fixed rate or an adjustable rate mortgage. If you decide to get a fixed rate mortgage, 30 year fixed rate mortgages are by far and away the most popular option, but you can get a 15 year fixed rate mortgage too. Due to the shape of the yield curve, 15 year mortgage rates are lower than 30 year mortgage rates, but you have a higher monthly payment due to the faster repayment of principal. Adjustable rate mortgages usually have a teaser period for which the rate is fixed, then after the rate adjusts based on the value of a short term index such as LIBOR or 1 Year Treasuries. Common adjustable rate mortgages are 3/1, 5/1, and 7/1, which adjust after 3, 5, and 7 years, respectively, and have a final maturity of 30 years. It's likely that you will save money over 30 years by using an adjustable rate mortgage, but the unpredictability of short term interest rates makes this option unsuitable for most borrowers.
Obtain Quotes From Several Lenders
Once you've decided how much money you need to borrow and the type of mortgage you need, its time to comparison shop for the lowest rate. This probably is the easiest part. You can use a service likewhere you can enter information about the type of mortgage you are looking for, your state, and property type, and you will receive quotations from several reliable lenders allowing you to obtain the lowest mortgage rate for your property. The service is easy to use, and you'll get 4 offers online relatively fast. It's nice to see lenders competing for your business.
Other Ways to Reduce Your Mortgage Rate
Everyone knows that the size of their monthly mortgage payments is proportional to the size of their down payment, but what most people fail to realize that their mortgage rate is tied to their down payment size as well. Loan-to-value ratio indicates what your house is worth versus the amount you're borrowing. When you first purchase a house, generally the difference between the two is the down payment, depending on how much the house appraises for. Currently, low rates are reserved for those borrowing less than 80% of their home's value. If you plan to put 20% down and your home appraises for less than the sale price, the lender will decrease the size of your mortgage that you can qualify for at the low rate.
If a 20% down payment is not made, lenders usually require the home buyer to purchase private mortgage insurance (PMI) to protect themselves if the home buyer fails to pay. Premiums are up in most parts of the country, and the lenders are restricting coverage in various ways. Mortgage insurance is scarce for buyers who want to put only 5 percent down. In declining housing markets, meaning practically all of them, the insurers might want 10 or 15 percent down.
Another way to reduce your "effective mortgage rate" or the size of your monthly payment is to pay "points". Through points, you are paying interest in a lump sum upfront that allows you to get a lower rate on your mortgage. Each point is equivalent to 1% of the loan amount. If you have the money to make the upfront payment for points, you need to decide how long you expect to have the mortgage. The longer you plan to have your mortgage, the more it makes sense to pay for points now because you'll have a long time to benefit from the lower rate.
Maintain a low debt-to-income ratio. Your debt-to-income ratio reflects your financial life and is used to estimate how much you can afford to borrow by comparing your monthly debt payments -- house, car, credit cards, student loans, etc. -- to your gross, or before-tax, income. Today lenders would like to see that ratio at 45% or less.
Gather Necessary Documentation
Get all necessary financial paperwork together before meeting with a lender, including:
- Tax returns for the past two years.
- W-2 income statements.
- Two most recent pay stubs.
- Most recent credit card statements.
- Most recent bank and investment account statements.
- Divorce decrees and child-support documents.
- Your budget.
That's it, you're on your way to getting the low mortgage interest rates that you deserve!
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