Discover methods to obtain the lowest interest rate
Achieving the lowest mortgage rate can be influenced by maintaining good credit, making a bigger down payment, and selecting the right type and duration of your mortgage.
While aspects affecting mortgage rates, like the Federal Reserve’s actions in response to the economy, are outside your control, there are strategies you can adopt while shopping for a mortgage that may help you lower your interest rate. These strategies include comparing lenders, locking in your rate, and purchasing points. Discover more about securing the best mortgage rate.
Key Takeaways
- Improving your credit score is a crucial step toward obtaining the lowest mortgage rate.
- Increasing your income, reducing debt, and saving for a larger down payment can also lead to better interest rates.
- Shop around for different mortgage types and terms, and obtain quotes from several lenders.
- Paying cash upfront can help lower your mortgage interest rate, but it may not always be the wisest financial decision.
How Much Can You Save With a Reduced Mortgage Rate?
Even a minor decrease in your mortgage rate can lead to substantial savings each year. The table below illustrates how three varying mortgage rates affect monthly payments and total interest over a 30-year fixed-rate mortgage for a $400,000 loan.
| Interest Rate | Monthly Payment | Total Interest |
|---|---|---|
| 8.25% | $3,005 | $681,820 |
| 7.5% | $2,797 | $606,867 |
| 6.5% | $2,529 | $510,180 |
Improving Your Credit Profile
Several financial elements influence your perceived risk to a mortgage lender, which, in turn, determines the interest rate for which you qualify. You can take steps to enhance each aspect of your credit profile before applying for a mortgage to secure a lower rate.
- Credit Score: Borrowers with outstanding credit typically qualify for the best mortgage rates. To enhance your credit score, check your free credit report at AnnualCreditReport.com. Dispute any inaccuracies with credit bureaus. Focus on lowering your credit utilization by paying off debts and ensure timely payments to create a solid payment history. The Consumer Financial Protection Bureau provides a tool to see how your credit score could impact your interest rate.
- Debt-to-Income Ratio: Mortgage lenders assess your capacity to repay your loan by considering the portion of your monthly income that goes toward minimum debt payments, known as your debt-to-income ratio (DTI). Some lenders may set a maximum DTI limit. You can improve your DTI by paying off debts or increasing your income, potentially through a side job.
- Cash Reserves: Lenders also review your liquid assets, like savings and easily accessible investments, to evaluate your mortgage eligibility. Those with low credit scores or high DTIs may be required to show cash reserves. As you prepare for home buying, consider placing some funds in a high-yield savings or brokerage account. If cash reserves aren’t needed, you can utilize these funds to buy points or make a larger down payment, both of which may lead to a lower interest rate.
Shopping Strategies
Compare Various Types of Mortgages
When looking for a mortgage, evaluate rates across different home loan types. “Currently, government-backed loans generally have better rates,” says Kristina Morales, a licensed mortgage loan originator and founder of Loanfully. This category includes FHA loans, VA loans, and USDA loans.
However, consider costs beyond the interest rate. For instance, FHA loans mandate mortgage insurance premiums, while VA and USDA loans may involve funding or guarantee fees. Your credit profile will influence which loan type yields the best rate.
Note
Shorter-term mortgages usually have lower rates than 30-year loans. Since you’re paying interest for less time, a 15-year mortgage can save you money, but be sure you can manage the higher monthly payment.
Adjustable-rate mortgages (ARMs) often provide lower starting rates. An ARM typically has a fixed rate for an introductory period (e.g., five years), after which the interest rate adjusts periodically.
Be cautious, as your monthly payment could increase once the fixed period ends. While many lenders suggest ARMs for buyers who plan to refinance or sell before the fixed period concludes, this largely depends on the housing market and your future financial plans.
Compare Mortgage Lenders
“Shopping around is one method to ensure you secure the lowest rate,” Morales advises. Different lenders may offer varying rates to the same borrower, so obtain several rate quotes. To minimize the impact on your credit, gather pre-approvals from different lenders within a two-week timeframe.
Research from Freddie Mac indicates that borrowers who seek quotes from two lenders might save up to $600 annually, while those who request at least four quotes could save more than $1,200 per year.
Tip
When comparing lenders, focus on other elements besides the rate. Assess lender fees, their ability to complete closings on time, and the responsiveness of the loan officer.
Explore First-Time Home Buyer Programs
Most state housing finance agencies provide down payment assistance for first-time buyers, often without repayment conditions. Many localities also offer their own programs, with income limits and requirements that vary by area. These initiatives can help boost your down payment, potentially leading to a lower mortgage rate. Moreover, Housing Choice Voucher recipients may qualify for homeownership vouchers to assist with both upfront and ongoing costs.
Loan Purchase Choices
Lock in Your Rate
Many lenders allow you to lock your mortgage rate, ensuring it remains unchanged before closing unless your application changes. If rates rise after you lock in, “you will avoid the additional interest costs,” Morales mentions. However, if rates drop, locking in your rate may result in losing out on a better deal.
Make a Larger Down Payment
Increasing your down payment can affect your mortgage costs in several ways:
- More money down means borrowing less, leading to interest on a smaller loan amount.
- Putting down at least 20% can help you avoid private mortgage insurance (PMI) on conventional loans. A larger down payment may also lower your annual mortgage insurance costs on FHA loans.
- A bigger down payment lowers your loan-to-value ratio, which could entice the lender to offer a better mortgage rate. Nevertheless, the Consumer Financial Protection Bureau notes that you might secure a slightly lower rate with less than a 20% down payment due to PMI mitigating the lender’s risk.
It’s important to calculate the total cost of borrowing (including PMI) instead of just comparing the mortgage rates linked to various down payment percentages.
Purchase Points
Most lenders allow the purchase of discount points to lower your mortgage rate. One point represents 1% of the loan amount, and the lender specifies the interest rate reduction it provides in your loan estimate.
Buying points isn’t always the best choice. Morales recommends considering several aspects:
- Availability of Cash: Closing costs can be steep, and you may not have adequate cash available to buy points. Even if you do have funds, putting that money toward a larger down payment might be more advantageous, so compare the overall borrowing costs of your alternatives.
- Monthly Payment Impact: The rate reduction from buying points varies by lender. “If it only saves the borrower $15 to $30 monthly, it could be wiser to retain the cash,” Morales warns. Consider using the funds for a high-yield savings or investment account instead, which introduces an opportunity cost.
- Break-even Point: “Borrowers need to ascertain how long it will take to recoup the extra expense incurred when purchasing discount points,” Morales advises. For instance, if you would take five years to recover the cost of points through monthly savings, consider whether you might sell or refinance before then.
Additional Factors Influencing Your Mortgage Rate
- Homebuyer Demand: A robust economy and low unemployment rates can increase homebuyer demand for mortgages. As lenders have a limited amount of money to lend, higher demand may lead to increased mortgage rates. Conversely, little demand can cause lenders to lower their rates.
- Inflation Rates: High inflation may diminish the lender’s return, particularly for longer-term, fixed-rate mortgages, often resulting in increased interest rates during inflationary periods.
- Federal Reserve Monetary Policy: The Fed alters the federal funds rate to either stimulate or restrict economic activity by changing the cost of borrowing for businesses and consumers. The lowest average rate of 2.65% for a 30-year fixed-rate mortgage occurred in January 2021. Although the Fed doesn’t directly set mortgage rates, a high federal funds rate generally correlates with higher mortgage rates.
Frequently Asked Questions (FAQs)
How Can I Obtain a Lower Interest Rate on a Mortgage?
Improve your credit score, boost your income, make a larger down payment, or consider a shorter-term mortgage to secure a lower interest rate. Comparing different lenders can also help, as could buying points upfront to reduce your rate in certain situations.
How Do I Request a Lower Mortgage Rate?
You can always ask your lender for a lower rate, though they may expect you to buy points in exchange. Shopping around can yield better rates.
Is it Possible to Negotiate Mortgage Rates?
Yes, mortgage rates are negotiable to some degree. You’re more likely to succeed if you have a solid credit profile and provide a significant down payment. Comparing lenders is also beneficial in obtaining a lower rate.
Can I Reduce My Mortgage Interest?
Refinancing to secure a lower interest rate is one method to reduce mortgage interest. This process replaces your existing loan with a new one, potentially resulting in a lower monthly payment, but keep upfront costs in mind. You may also consider making extra principal payments to decrease overall interest paid over time.