In this article
- 1. Use a Mortgage Calculator
- 2. Improve Your Credit Score
- 3. Lower Your Debt-to-Income Ratio
- 4. Research Home Buying Assistance Programs
- 5. Avoid PMI By Making a Down Payment of at Least 20%
- 6. Select a Shorter Loan Term Length
- 7. Select the Best Mortgage Type for You
- 8. Pay for Interest Reduction Points Up Front
- 9. Shop Around for Rates
One of the biggest financial decisions that you will ever have to make in your life is buying a home and one of the most critical aspects of the home buying process is choosing the right mortgage for your needs.
Mortgages come in all shapes and sizes, and interest rates often vary significantly from one lender to the next. The interest rate is essentially the price of borrowing money and even just a small difference in rate can translate to a significant difference in the total costs.
For instance, if you take a 30-year, fixed rate mortgage with an interest rate of 3%, you would have to pay $843 each month, and you will pay $103,555 in interest over the life of that loan. However, if the same loan had an interest rate of 5%, you would have to pay $1,074 each month, and $186,512 in interest over the life of the loan.
A difference of just 2% in the interest rate translates to about $83,000 in extra interest charges over the term of the loan.
So, while shopping for a mortgage, it is always important to ensure that you get the best rate. Here are 9 tips to help you to do exactly that and save money on your mortgage in various other ways.
1. Use a Mortgage Calculator
Mortgages tend to be complex, and even tiny changes in their terms can end up affecting your total costs significantly. Using a mortgage calculator is a good first step towards understanding your future.
You can find good mortgage calculators online that will allow you to tweak the interest rate and terms to see how they affect the monthly payments and overall costs. It can also help you get a sense of how much you can afford.
2. Improve Your Credit Score
Your credit score plays a key role in determining the rate that you are offered. Lenders consider credit scores as a representation of your likelihood of repaying a loan. The higher the score, the better the interest rate you will likely be offered.
Lenders typically have minimum credit scores to qualify for conventional mortgages. You will need to have a credit score of at least 620 to get most conventional mortgages, and a score of 580 or higher to get the lowest down payment requirement for an FHA loan.
Still, the best rates are offered to those whose credit scores are in the mid-700s or higher. If you have a score lower than that, you should consider focusing on improving it prior to applying for a mortgage.
Request copies of your credit report from the 3 major credit bureaus. You are entitled to a free copy each year. Look through your credit report to see whether there are any disputable errors. Commit yourself to paying down debts, paying bills on time, and staying below the credit limit on your credit cards.
3. Lower Your Debt-to-Income Ratio
One key metric used by lenders when evaluating applications is the “debt-to-income” (DTI) ratio. It measures all your monthly obligations compared to your earnings. Lenders consider the DTI to determine whether you are capable of handling your mortgage payments each month.
A higher DTI could mean that you are more likely to struggle with your payments. A DTI of 43 percent or higher (including the potential mortgage payment) is regarded as risky, while a ratio of 50 percent is the maximum for many mortgage types, including those from Fannie Mae.
If you pay down your debt, you will be more likely to qualify for a mortgage and get a better rate. Consider spending time reducing the balance on your credit cards or paying off your loans before you apply.
4. Research Home Buying Assistance Programs
A wide selection of both federal and state programs is available to help you afford a home, especially if you are a first-time homebuyer.
Federal programs include:
– USDA Loans: People living in rural areas can qualify for fixed-rate, lower-cost mortgages with zero down payment.
– VA Loans: Eligible veterans and service members may qualify for a mortgage with zero down payment.
– FHA Loans: Insured by the Department of Housing and Urban Development (HUD), these loans allow those whose credit scores are lower to qualify for a mortgage with a low down payment.
– Homeownership Vouchers: Available to qualifying low-income individuals that need help buying a home.
States usually offer more robust programs for first-time home buyers, which may include down payment assistance. Get in touch with your state housing finance agency or a HUD field office for additional information on such programs. Your lender can also help you find them.
5. Avoid PMI By Making a Down Payment of at Least 20%
Some loan types and lenders allow you to buy a home with a small down payment. If you put down less than 20% on a property, however, you will have to buy private mortgage insurance.
Often referred to as PMI, private mortgage insurance protects the lender in case you don’t make your payments. You will typically pay a PMI premium each month as part of your scheduled mortgage payment until when you are able to qualify to drop the insurance.
The monthly PMI premiums range between $30 and $70 for every $100,000 borrowed. So, if you would like to buy a $250,000 house, put 10 percent down ($25,000) and finance the remainder ($225,000), your PMI payment each month would be at least $60, but could end up as high as $140.
Since the PMI represents an extra cost, saving up to make a down payment of 20 percent, you can end up saving money down the road.
6. Select a Shorter Loan Term Length
The most common option is the 30-year mortgage, but you have multiple options when it comes to the length of the loan. Lenders typically offer 10-year, 15-year, and even 20-year mortgages.
The shorter the length of the mortgage, the higher the monthly payments will likely be. However, you will also get lower rates and pay significantly less in interest over the life of the loan. If you are able to afford the higher monthly payment, you can end up saving a lot of money in the long term if you choose a shorter-term loan length.
7. Select the Best Mortgage Type for You
Different mortgage products work better for people with different financial situations. Here are the most common types of mortgage loans:
Conventional Loans: Are mortgages that are not part of any specific government program. In most instances, they are referred to as “conforming” loans that adhere to the rules set by the Federal Housing Finance Agency. They are ideal for people with good credit looking for low mortgage rates.
FHA Loans: Are mortgages that come from private lenders but are insured by the federal government and allow those that might not otherwise qualify for a mortgage to buy a home. FHA loans can be a great option for those that don’t qualify for conventional loans, but can be more expensive in the long run.
Jumbo Loans: Are loans with bigger limits than those set for conforming loans. They can be as large as $1 million or even more.
USDA Loans: Are programs from the U.S.D.A. that either insure loans from private lenders or lend money directly to low-income individuals in rural areas. They offer qualifying individuals no-down-payment loans.
VA Loans: Are mortgages that are provided by the Department of Veterans Affairs to both veterans and active service members. Qualifying borrowers can purchase a home without any down payment.
8. Pay for Interest Reduction Points Up Front
If you pay points at your mortgage closing, you are basically paying a fee in exchange for a lower rate of interest. Your lender may also refer to these as mortgage points, discount points, or prepaid interest. 1 point is usually 1% of the loan amount. The amount each point reduces the interest rate will depend on the lender.
Paying points makes the most sense if you know that you will be in the home for a longer period of time. It takes time for the lower interest and lower monthly payments to recover the money paid upfront for points.
9. Shop Around for Rates
It is generally advisable to compare at least 5 different loan estimates to find the best rate. If you do that, you can save an average of $3,000. Using a dedicated service for this can make it easier for you to shop for rates.
You simply have to fill out your information once and can check rates with multiple lenders. When evaluating different loan offers, ensure that you pay attention to more than just the mortgage rates. You should also look at the closing costs, fees, and other charges likely to affect the amount you pay overall.
Since there are so many costs associated with buying a home and getting a mortgage, you should always try to compare APRs from different lenders. APR incorporates the interest rate and all other costs of the mortgage, which means that it can paint a better picture of the loan’s total cost.