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Mortgage Loan Types, Credit Score, and more: 5 Tips to Get the Best Mortgage Rate
Read Time: 5 Minutes|
November 26, 2021
Buying a home in cash is not feasible for most people; that’s where a mortgage comes into play. Home financing is how the majority of home-buyers become homeowners. If you’re thinking about applying for a mortgage, a good place to start is figuring out how much home you can afford and, equally, how much you feel comfortable spending on a mortgage payment every month. Because your interest rate is a huge part of the monthly payment, understanding how you can get the most bang for your buck (home AND payment wise) can save you stress as you go through the home buying process – and money down the line.
Consider a Fixed-Rate Mortgage
Fixed-rate mortgages are the most common loan option among borrowers. The rate stays the same throughout the life of the loan, meaning the monthly mortgage payment does not change (compared to an adjustable-rate mortgage). Many borrowers choose a 30-year fixed for affordability and predictability, but there are other options such as 25, 15, and 10-year options.
According to data from Freddie Mac, interest rates in 2021 were historically low, sitting under or close to 3.0% month over month. This is the most cost-effective, advantages time in the market to buy a home or refinance, simply because the lower the rate, the less money you have to pay back on interest over the life of the loan.
In 2022, rates are projected to rise. So, how do rising rate impact refinancing and buying opportunities for borrowers? Let’s look at a theoretical rate example. Does a 4.00% interest rate versus 3.75% make a major financial difference for a borrower? Short answer: Yes!
Forbes noted, “Over the course of a 30-year loan, the difference between a 4.00% interest rate and a 3.75% interest rate is more than $5,000 for every $100,000 you borrow." To put this into perspective, for a $300,000 mortgage loan, you could save $15,000 over the life of your loan, which could be used for:
- A college fund*
- A down payment on a new car*
- A down payment on a second home*
- Investing in stocks, bonds, ETFs and more*
The bottom line: Lower interest rates are a borrower’s best friend! While rates are predicted to rise, now is still a good time to consider applying for a home loan or refinancing.
Optimize Your Credit Score
Odds are, at some point in your life, the significance of establishing and maintaining good credit surfaced. Maybe it was when you applied for an auto loan to purchase your first car. Maybe it was when you started using a credit card. Either way, understanding how credit impacts borrowing money, especially from a mortgage lender, is crucial. So, what makes up your credit score?
- Payment history – 35%
- Credit utilization – 30%
- Length of credit history – 15%
- Number of inquiries – 10%
- Types of credit – 10%
Tips to Increase Mortgage Approval Odds (Credit edition):
- Pay bills on time
- Pay down major debt
- Pay credit card balances in full
- Take a look at your credit report
- Correct any errors listed on the report
Because credit is one of the risk-determining factors lenders consider when you apply for a home loan, it’s a good idea to ensure you have the highest score possible to present. With many loans and lenders, the higher the credit score, the lower the interest rate. The lower the interest rate, the lower the monthly mortgage payment.
Lower your Debt-to-Income (DTI) Ratio
Your debt-to-income ratio is your monthly debt divided by your gross monthly income. The percentage paints a picture of your finances and affordability, showing how much you currently spend versus your cash flow.
DTI helps lenders gauge the risk involved with lending you a mortgage. What this really means is, lenders prefer borrowers to have a lower DTI because in theory, the less debt you have, the more likely you’ll be able to make your monthly mortgage payments and default on your loan.
Tips to Lower Your DTI:
- Pay off loans early
- Avoid taking on more debt
- Make extra payments
- Increase cash flow
Depending on the loan type, lenders may accept a higher DTI. However, it’s best practice to aim for a DTI close to 36% (or less).
Figure Out Your Down Payment
Your down payment is another factor lenders consider when qualifying for you a loan. There are loan options that require zero money down and some that require just 3% down. Sometimes, having more money to put down can open up more financing options to choose from. As a general rule of thumb, saving as much money as possible for a down payment is a smart move for the majority of home-buyers.
Consider an Adjustable-Rate Mortgage
An Adjustable-Rate Mortgage (ARM) is a type of mortgage with an interest rate that changes (adjusts) throughout the life of the loan – after a fixed-rate period. With this loan, you lock in a low mortgage rate for 5, 7, or 10 years, then the interest rate changes periodically thereafter, based on the market at the time. With a conventional ARM, the rate changes every 6 months.
What’s particularly attractive about ARMs to borrowers is that they typically offer the lowest possible mortgage rate, compared to a 30-year fixed loan term. Generally, lower rates equate to a lower monthly mortgage payment.
With lower rates and flexible loan terms, this an ideal loan type for a variety of home-buyers, including college graduates needing to pay off debt, growing families, someone who plans to relocate, a homeowner living in a temporary home, a borrower looking to refinance before the rate changes, or a home-buyer looking to buy when interest rates are higher. So, if you’re not quite ready to buy until next year, and rates follow predictions and increase in 2022, an ARM may be a smart move.
It’s important to note that ARMs allow borrowers to refinance. Many borrowers reach out to their loan officer to see if there are any opportunities to save money by refinancing prior to the adjusted-rate period begins.
FHA loans are mortgages insured by the Federal Housing Administration, a federal agency within the Department of Housing and Urban Development. Because FHA loans are government-assisted and insured, they are more accessible for borrowers (compared to conventional loans).An FHA loan is a great option if you want to put less money down, don’t have enough savings built up for a conventional loan requirement of 20% down, or have a lower credit score
VA Loans are guaranteed by the U.S. Department of Veterans Affairs, which means we’re able to offer more favorable loan terms and flexible qualifying criteria to military home buyers. VA loans generally offer lower average interest rates and allow borrowers to finance 100% of their home purchase.
USDA loans are ideal for borrowers with low-to-moderate income looking to purchase a home in a rural area. The home loan allows borrowers to finance up to 100%, with zero money down.
Freddie Mac HomePossible® is conventional mortgage program that is perfect for first-time homebuyers, millennials, and low-to-moderate income borrowers. It offers a low down payment required of just 3%.
Explore more loan types here.
Research, Prepare and Take the Next Step
As you’ve probably figured out by now, your mortgage interest rate depends highly on the current market rates and a variety of factors unique to you. Whether you’re ready to buy now while rates are still low or you’re curious about your financing options down the road, a Newrez loan officer is happy to help!
*This is not financial advice, always consult with a financial advisor before making any decisions
Learn more in our other educational series.
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