Getting a mortgage can be a pretty daunting experience. A mortgage is a loan that you could be repaying for the rest of your life, and the rate determines how much you’ll pay for the money you borrow, which in turn affects your monthly payment for the coming years.
There is more to getting a reasonable mortgage rate than merely having a good credit score (though that’s important). Lenders evaluate a wide variety of factors when determining what sort of rate to offer you, and whether to approve you for the loan in the first place.
Mortgage rates can vary by several percentage points, and when compounded over a 15- or 30-year period, those percentage points can add up to many thousands of dollars. To optimize your chances of getting the best rates available, you’ll want to be very well qualified and to know what the lenders will be looking for ahead of time.
1. Build and Keep a High FICO Score
This is perhaps the first and most obvious thing you would think a mortgage lender would be looking for, but it makes sense to start here.
Among the criteria used to determine your mortgage rate, the FICO score is foremost. It will help the lender determine whether you qualify for the loan at all, and if so, what rate to charge you. Most lenders break their rates down into tiers, which are determined by credit score. If you have a high credit score, you’ll pay their lowest rate, while if you have a low credit score, you’ll pay their highest rate (or have your application denied).
The lowest mortgage interest rates are available to borrowers with FICO scores of 760 or better. If you have a lower score, your rate will be slightly higher. With a handful of exceptions, the lowest score needed to qualify for a mortgage is 620. In today’s lending rates, a score of 620 may qualify for a rate of 5.022%, while a borrower with a score of 760 will be offered a rate of 3.433%.
You may be able to obtain a mortgage in certain cases with a FICO score as low as 500, but the lender will require a down payment of ten percent. To get the maximum financing on an FHA loan, which has a 3.5% down payment, you would need a credit score of 580.
If your credit score is low right now, start tracking it using online services and pay off debts like car loans and credit card balances. Also, be sure to pay any past-due accounts, including those sent to collections, and resolve any issues you find with your credit report.
2. Maintain Income Stability and Employment History
Lenders tend to like candidates that can prove they have been consistently employed for the past two years. If you have been unemployed for a long time, that will not help your application. Neither will a trend of declining earnings.
To be an ideal candidate, you will have been working at the same job for two years or more, ideally with regular raises, or have transferred to a better-paying job at some point during that timeframe.
Lenders tend to be most strict in the area of self-employment income and require documentation of business income with tax returns for the past two years. They usually require you to file IRS form 4506, which will allow them to obtain a transcript of your returns to make sure the ones you sent to the IRS are the same ones you showed them as proof of income.
3. Preserve a Moderate Debt-to-Income Ratio
DTI, or debt-to-income ratio, comes in two types. Your back-end ratio is the ratio of all your monthly minimum debt payments plus your housing payment, divided by your stable monthly gross income.
The front-end ratio is the ratio of your housing costs to your monthly income, minus all other debts,. Generally, banks like to see a front-end ratio of no more than 28%, with a back-end ratio of no more than 36%.
These ratios may vary depending on the type of mortgage and other factors involved. A maximum back-end DTI of 43%, for example, is allowed with an FHA loan. You may be granted more flexibility if you are very good in all the other categories.
4. Make a 20% Down Payment
Generally, you will need to have 20% of the purchase price of your home saved as a down payment if you want to qualify for the best mortgage rates. This is because lenders quantify risk based on this number. The more you have saved up for a down payment, the lower risk you are deemed to be. If, for example, you have only a five percent down payment, you would be considered a much higher risk applicant and offered a higher interest rate accordingly.
Furthermore, if you don’t have the full 20% saved for a down payment, you will be required to get Private Mortgage Insurance or PMI. PMI on a mortgage with a five percent down payment, for example, would add about $103 per month or $1,240 per year onto your house payment, and that’s before factoring in the higher interest rate you would be offered!
5. Have Several Months of Payments Saved
Mortgage lenders like to see several months’ worth of house payments saved up and held in reserve, beyond the down payment. They call this “cash reserves,” and it is another risk factor they look at when determining what interest rate to charge you. This money must be liquid or readily available and cannot be stored in retirement accounts. Good places to keep cash reserves include savings and checking accounts, money market funds, and deposit certificates.
6. Compare a Variety of Lenders
Last but not least, once you have all these factors lined up, be sure to comparison shop across a wide variety of lenders. If you have all these things in order, you will be a great candidate for a mortgage, and you deserve an excellent rate. Take advantage of internet searches and comparison services, and also your bank or credit union, who might have better rates for preexisting customers.
Hopefully, this information will have you well on your way to finding and getting the best mortgage rate you can. If you have any tips you’d like to share with others seeking the best mortgage rates, feel free to share them here in the comments below.