Buying a new home is a significant milestone in our lives—it is also a serious financial commitment. Finding the best mortgage rate can be a daunting task. The best way to get the lowest possible rate is to first put yourself in a positive financial position, then dig into comparison shopping.
How the Mortgage Industry Determines if You Qualify and Your Rate
As Rob Berger writes in his article for Forbes “6 Tricks To Getting A Great Mortgage Rate,” there are a lot of factors at stake that can determine if you qualify for a mortgage and what sort of rate you will have to pay. It starts with you positioning yourself to get qualify and to get that low rate you want. One such factor is your FICO credit score. According to myFICO.com, a 30-year fixed rate at 3.629% APR is awarded to those with a score of 760 or higher. The lower the credit score, the higher your rate will be. If you have a low credit score, start there first. Pay off and loans you currently have and resolve any discrepancies in your credit score. Here are the other factors that Berger has outlined:
- Stable Employment and Income Track Record: at the bare minimum, be able to prove that you have had both for the last two years.
- Debt-to-Income Ratio: also known as DTI, there are two different ratios. The back-end ratio measures all total monthly minimum debt payments, plus proposed new housing payment, divided by monthly gross income. Bank wants to see no more than 36%. Front-end measures your housing costs. Banks want to see no more than 28%.
- Down Payment: putting down 20-25% down will help make sure you get a lower rate, but you do not have to put down that much. With certain loan programs, you can put down as little as 3%.
- Cash Reserves: typically need at least 60 days’ worth of cash reserves. Here is some more information regarding what you should expect when asked what your reserves are like.
Now You Are Ready for Comparison Shopping
After going through the hoops to get yourself into the best financial position possible, you can now start comparison shopping. You can use Bankrate’s Compare Mortgages Table and this useful tool to shop around for rates as a jumping off point. But you might have other questions as you go through this process. Here are the top three questions you might have:
- Should I look into getting a fixed or adjustable rate?
The difference between the two is a fixed rate will not change for the duration of the loan, while an adjustable rate can change. The adjustable rate is a double-edged sword—it can offer you a lower introductory rate but it can go up significantly in the future.
- Is it worth paying for points?
As Nerdwallet states, it is only worth to pay for points—1% of the total mortgage amount —to get a lower interest rate if you are going to stay for a long period of time. If you plan on selling in the near future to upgrade or downsize, then it will probably not be worth it.
- What will be my closing costs? ‘
You should expect to pay in the ballpark of 2 to 5% of the loan value. You can use this closing cost calculator to get a better idea.