Even a 1% difference in the mortgage rate can save a homeowner $40,000 over 30 years for a mortgage valued at $200,000. Having a top-notch credit score plays a critical factor in determining what interest rate lenders will offer consumers, but other issues such as the amount of your down payment also impact it.
Improve Your Credit Score
A high credit score is the key to ensuring that borrowers receive a low mortgage rate. Here’s a quick rundown of what the numbers mean – a score of anything below 620 ranks as poor, 620-699 is fair, 700-749 is good and anything over 750 is excellent.
Review your credit reports for any inaccuracies such as an incorrect outstanding balance on a credit card and correct them, said Kevin Gallegos, vice president of the Phoenix operations for Freedom Financial Network, a consumer debt resolution company. Some prospective homeowners looking to shore up their credit consider costly credit repair services, but it's best to avoid the, Gallegos argues, because you can make the disputes yourself, he recommends.
Think carefully before canceling a credit card with a long, positive history. The longer you hold a card, the more valuable it is in your credit score determination, Gallegos said. If you have more than one card and want to use only one, store the others away but do not close the accounts.
Decrease your credit card debt. One of the biggest factors which impacts your credit score is your credit utilization ratio. Your goal should be to get this as low as possible, said Jason van den Brand, CEO of Lenda, a San Francisco-based online home mortgage service.
If you're carrying balances on credit cards that exceed 50% of the available credit, then you're hurting your credit score. Strive to get your total credit utilization under 50% first and then keep going until you get it under 30%.
“This is one of the fastest ways to increase your credit score,” he said. “You could also call your credit card companies and ask them to increase your credit line.”
Shop for rates within 30 to 45 days of your closing date since borrowers can apply with multiple lenders within this period and it won't negatively impact their credit score, van den Brand said. Each lender will want to check your credit, but the only credit pull that impacts your credit score is the first one.
Work With Your Bank For Lower Rates
Rather than jumping at the most tantalizing advertised rates, form a relationship with a mortgage banker that is willing to watch the market for you, said Dan Smith, president of Atlanta-based PrivatePlus Mortgage. One of the challenges is that mortgage rates often change very quickly, and these rate movements are not visible to the consumer in real time, he said.
“Most mortgage bankers have real time access to market improvements and are able to take advantage of them when they happen,” Smith said. “More often than not, bankers will call a consumer to let them know their target rate has become available before the consumer has any idea.”
It pays to be organized, since not having all your financial documentation in order is one of the biggest bottle necks in getting a mortgage application complete and interest rates move daily, said van den Brand.
“Usually you can only lock your interest rate for 30 days without incurring additional fees,” he said.
Opt For an FHA or ARM
Both an adjustable rate mortgage (ARM) and a Federal Housing Administration (FHA) mortgage are good options if homeowners are concerned about receiving a lower interest rate and have not been able to accumulate the 20% standard down payment.
The biggest benefit of an ARM is that they have lower interest rates than the more common 30-year fixed rate mortgage. Many ARMs are called a 5/1 or 7/1, which means that they are fixed at the introductory interest rate for five or seven years and then readjust every year after that, said David Reiss, a law professor at Brooklyn Law School in N.Y. The new rate is based on an index, perhaps LIBOR, as well as a margin on top of that index.
While many homeowners gravitate toward a 30-year mortgage, younger owners “should seriously consider getting an ARM if they think that they might move sooner rather than later,” he said.
FHA loans can be a good option for consumers purchasing their first home because they require much smaller down payment of 3.5%. They also do not require high FICO scores, but buyers must pay private mortgage insurance (PMI) each month, which adds to the cost of the loan. Given that young households tend not to have the savings for a substantial down payment, they can be an attractive option, Reiss said.
Borrowers should also look into home affordability programs. State and local housing agencies, government agencies and financial institutions offer loan options which could provide both low interest rates and low down payments.
One option for borrowers looking for a low interest mortgage is TD Bank’s Right Step program, which provides qualified home buyers with an alternative to FHA- backed loan products and features a 3% down payment option, said Malcolm Hollensteiner, director of retail lending sales for TD Bank in Cherry Hill, N.J. Borrowers will also see “significant” savings on their monthly mortgage payment thanks to the loan's elimination of the private mortgage insurance requirement.
Avoid Private Mortgage Insurance Costs
Homeowners who are able to afford a 20% down payment do not have to pay PMI, which costs another 0.5% to 1.0% and can tack on more money each month. Having at least 20% in equity shows you have “more skin in the game and this usually means a better interest rate because of the lower risk of default,” said van den Brand.
“It's important to remember that the costs of a loan are closely associated to how ‘risky’ it is to give the loan,” he said. “If you look like a riskier borrower, your loan will cost more.”
--Written by Ellen Chang for MainStreet