How can you get a better interest rate? How can you prepare yourself on the way to buy a house?
When you buy a house, the first number that concerns you is the house price, but the interest rate is also crucial if you need to borrow money to purchase a house. If you can get a better interest rate, it will save you a lot of money.
The mortgage interest rate is composed of many factors, such as mortgage type, location, loan amount, percentage of down payment, loan term, credit score, property type, and use and discount point. According to each one of the applicant’s conditions and situations, the rate most likely won’t be the same.
Of all the factors that impact the interest rate, how many are the ones that you can improve? If you can improve these factors before you apply for the loan, for sure you can get a better mortgage interest rate than others who are not prepared. Here are some points you should consider.
Maintain a good credit score
When you apply for a loan, the first thing that your loan officer will do is pull your credit report. This credit report contains your credit scores from three credit bureaus (Experian, TransUnion, and Equifax).
Your credit score gives lenders a snapshot of your experience managing your debts, and they use this information to predict how you might handle your mortgage in the future.
Rating FICO® Score Ranges
Exceptional 800-850
Very good 740-799
Good 670-739
Fair 580-669
Poor 300-579
A higher credit score means you will be a strong borrower and you will repay your loan as agreed. If they don’t see you as a risk, lenders will mostly offer a low interest rate.
Down payment, save as much as you can
It is true that you don’t need to save up to 20% of the house price to buy your home, but it is also true, if you put more money in a down payment, you will have a better interest rate.
Down payment is important because it impacts in many ways.
First, it has to do with LTV, loan to value. A loan-to-value (LTV) ratio measures the size of your mortgage to the value of your property. Lenders use your LTV ratio to determine your interest rate, monthly payment, and your loan amount.
Anything above 80% is considered a high LTV and required to pay PMI (Private Mortgage Insurance).
A “low-LTV” loan means you’re borrowing less money, and you are investing more cash in the home you’re buying. In lenders’ eyes, if you are putting more of your own money, means the chance you default the payments on your house is lower, so you will usually qualify for a lower interest rate because you’re considered to be less risky.
Second, you need to be careful if you put a lower down payment will make your loan amount exceeds the conventional loan limits (for 2023 is $726,200) and be classified as Jumbo Loan, which for lenders means more risk, usually carry a higher interest rate too.
Keep your debts as low as possible
The other number that lenders are looking at is the DTI (Debt to Income). This is the percentage between your total monthly debts and your total monthly gross income. This determines your loan approval and interest rate.
Total monthly debts are determined by adding the normal and recurring monthly debt payments such as monthly housing costs, car payments, minimum credit card payments, personal loan payments, student loans, child support, alimony, and other things.
A good DTI is considered below 36%, but generally, borrowers may qualify for a mortgage with a DTI of up to 43%, some loan programs can even agree to a DTI of up to 50%, but the interest rate varies according to the DTI ratio.
If a borrower has an $8,000 monthly gross income, a good DTI (36%) will be $2,880 as total monthly debt. As DTI is 43%, most lenders won’t like to see your total monthly debts exceed $3,440. If your other recurring monthly debts are $900, this means your monthly housing cost shouldn’t be over $2,540.
How to bring down your DTI ratio? By paying off your credit card and reducing debts. When you are considering buying a house, start with lowering your debts as much as you can, maybe by paying off your car loan, or reducing your student loan amount.
Loan terms impact your mortgage rate
Your loan term is the period of time that you have to repay your mortgage. In general, shorter loan terms have lower interest rates, but it also means higher monthly payments.
Loan terms can vary from 10 years to 30 years, with 15-, 20- and 30-year periods being the most common.
Any loan term shorter than 30 years, typically has lower mortgage rates because they are less risky for the lender.
Another important option to consider is between fixed-rate and adjustable-rate mortgages.
For fixed-rate mortgages, interest rates are fixed for the life of the loan. And adjustable-rate mortgages are only fixed for a certain amount of time (typically five, seven, or 10 years). After that, the rate fluctuates annually based on the market interest rate.
Adjustable-rate mortgages might offer lower interest rates upfront. But fixed-rate mortgages offer more stability over time.
One important factor to think about is how long you plan on staying in your house. For those who plan on staying long-term in a new house, fixed-rate mortgages may be the better option.
If you aren’t planning to stay in your new house for more than three to 10 years, though, an adjustable-rate mortgage may give you a better deal.
The best loan term depends on your specific situation and goals, so be sure to take into consideration what’s important to you when choosing a mortgage.
Buy Mortgage Points
The other resource is buying mortgage points when you apply for a loan, also known as discount points, which is an alternative way to lower the interest rate on your mortgage.
Mortgage points are fees you pay directly to your lender in exchange for a reduced interest rate on your home loan. There’s no set amount for how much a discount point will reduce the rate. The effect of a discount point varies by the lender, type of loan, and prevailing rates, as mortgage rates fluctuate daily — so it makes sense to shop around.
Before you buy points, run the math to determine the breakeven point—the number of months it will take for your total savings to add up to the cost of the points. If the time until the breakeven point is longer than you plan on owning your home, buying mortgage points may not be worth it for you.
How do you get the number of months? It’s by dividing the cost of the point ($8,000) by the monthly cost ($114), you determine how many months it would take you to make up the cost of buying the point.
The example showed $8,000 / $114, it’s about 70 months or almost six years.
If you planned to stay in the home for six years, you’d break even, and any longer than that, you’d save money. But if you moved out before then, you’d have lost money by buying points.
Property type and use also matter
Your rate can also be affected by the property type (Single Family House vs. condominium) and its location. Also, if it’s your primary residence or investment property. Usually, the investment property has a higher interest rate than the primary residence.
Last but not least
If you are about the purchase a house, waiting for the housing market and interest rate to be clear, in the meantime, you can do all the things we talk about above to help you in the future.
Remember, when you are close to buying a house or in the process of closing a purchase agreement, please do not apply for new credit cards, or new car loans, and don’t make large purchases, because all that will change your DTI ratio, and this will affect your repaying ability, and consequently, you are in risk of not getting your loan.
