How to Get the Lowest Mortgage Interest Rates
by Shawn Carvin, Senior Mortgage Banker
One of the biggest concerns for homebuyers during the home buying process is qualifying for the lowest mortgage interest rates. A little planning can make a significant difference in your interest rate and the total cost over the life of your mortgage.
Getting the lowest interest rate on a mortgage is about more than simply your credit score or comparison shopping. Lenders evaluate many factors when determining the mortgage interest rate you’ll be offered.
There’s no doubt that a borrower’s FICO credit score has a big impact on their ability to qualify for the best mortgage interest rates. In general, the best rates are available to borrowers with a score of 760 or higher. For example, at the time of publication, borrowers with excellent credit may be eligible for rates around 3.4%. In contrast, a borrower at or near the lowest qualifying credit score – currently 620 – can expect to pay an interest rate of around 5%.
If your credit score could use some improvement, this is where the planning comes in. Working to pay down high credit card balances, paying off past-due accounts, and resolving errors on your credit report will put you on your way to a higher score in no time.
Also known as DTI, debt-to-income ratio is a tool for evaluating the amount of debt a borrower carries compared with their income. There are two different ratios used by lenders. The “front end” ratio includes housing expenses – meaning the borrower’s projected monthly mortgage payment — and excludes other debts. Lenders generally prefer that borrowers have a front end ratio of 28% or less. The “back end” ratio is based on the total monthly minimum debt payments, including the projected mortgage payment. Lenders typically want borrowers to have a back end ratio of 36% or less. Qualifying DTI ratios vary by mortgage program – for example, FHA and VA mortgages are available to borrowers who have higher DTI ratios than cited here. However, a lower DTI usually results in a lower interest rate, all other factors being equal.
Employment and income
Lenders want buyers who can prove they have steady income and employment for at least the previous two years. Long stretches of unemployment will not help a borrower when applying for a loan. Banks want to see stable income, and they do not like to see a pattern of earnings declining, which may indicate the market value of the borrower’s skills is diminishing or is approaching obsolesces. Remaining at the same employer for the previous two years with evidence of increased compensation during that time will improve a borrower’s chances of qualifying for the lowest mortgage interest rates.
Different types of loans have different down payment requirements. To get the lowest mortgage interest rates, a down payment of 20% is ideal. A borrower with a 5% down payment is considered a greater risk and would be offered a higher interest rate.
Higher cash reserves can also earn a borrower a lower rate. Lenders measure cash reserves in terms of the number of months of total mortgage payments a borrower has in checking and savings accounts, money market funds, and certificates of deposit. Generally speaking, the minimum requirement for cash reserves is two months of mortgage payments left on hand after closing. Borrowers with significantly higher cash reserves will be more likely to qualify for the lowest mortgage interest rates.