The media is rife with advertisements telling you that unbelievably low mortgage interest rates are in the palm of your hands. Unfortunately, in many cases, borrowers find out that they only qualify for interest rates that are one to two percentage points higher than the average rate. So, what gives?
Basically, lenders see the mortgage interest rate as a representation of the risk involved in lending money to borrowers. A lower risk translates into favorable interest rates. You may ask then: How can I be a low-risk mortgage applicant? Lenders generally use certain criteria to determine if you qualify for an ultimately low interest rate.
Explained below are some of the major determinants that lenders typically consider when deciding whether to give you attractive mortgage rates.
A Credit Score of 760 or Higher
Lenders want to know if you're capable of paying back the money you intend to borrow. A high credit score is a good indication that you're a trustworthy payer. In contrast, if your credit score is low, it means you likely have a history of late and missed payments or other undesirable financial faults. A low score may indicate that you're not quite responsible in managing your finances, making you a high-risk applicant in the eyes of lenders.
In a nutshell, the higher your credit score, the better the interest rates you'll get. To access the most competitive rates, your credit score shouldn't fall below 760, which is considered a good score especially if you're planning to take out a 30-year mortgage. A credit score of 760 or higher opens the door to the most coveted mortgage rates and considerably lower down payments, as it implies that you have an excellent credit history and you have extremely low chances of becoming delinquent in your loans.
Generally, the minimum score to have your mortgage application approved is 620, although having this score means you'll likely end up paying much more for the debt you owe. However, those with very low credit scores ranging from 500 to 579 can still qualify for a mortgage by getting Federal Housing Administration-insured loans, which require a minimum of 10 percent down payment. Those with credit scores of at least 580 can get FHA-insured loans with as low as 3.5 percent down payment.
A Debt-to-Income Ratio of 40 Percent or Lower
Debt-to-income ratio refers to the portion of your gross monthly income that goes to debt payments, and you calculate it by dividing your debt amount by your total income. For example, if your gross income is $8,000 monthly and you have a total debt of $1,500 each month, your debt-to-income ratio would be around 0.19 percent.
A low debt-to-income ratio means lower mortgage interest rates. The ideal percentage to qualify for a new loan is no higher than 40 percent. Lenders take a look at your debt-to-income ratio when considering to grant your loan application, because they want to know if the new loan is within your means and it's not too hard for you to pay it off. They want to be assured that you're capable of making prompt payments consistently despite pay cuts, additional debts and other financial setbacks.
What do lenders consider as debt exactly? Generally, anything that's stated on your credit report can be seen as debt, including personal loans, credit card debts and auto loan debts. Future mortgage payments also are usually taken into account.
A Stable Job
Lenders want to check if you have a stable and consistent career, because a stable job means better capability of paying off a loan for long-term. A long-standing career indicates stability and bolsters your chances of getting the best mortgage rates. That said, don't panic if you changed jobs before. The important factor is that your previous jobs and current work are in the same industry.
Ideally, you should have a job in the same industry for at least two years. On the other hand, being unemployed or having been fired in the recent years won't help you get favorable rates, so remember to keep your job for as long as you can to secure excellent mortgage rates in the future.
An Equity Equal to 20 Percent or More
From a lender's perspective, having more equity means a lower risk. In a real estate context, equity refers to your home's market value after deducting your remaining mortgage balance. For example, if your home value is worth $600,000 and you have a remaining mortgage balance of $500,000, then you have a 17 percent home equity. Basically, this means you own 17 percent of your home property, and the lender owns 83 percent of it.
How does equity represent risk? If the value of your home decreases by up to 17 percent, you'd incur loss if you decide to sell your property, and you'll have to come up with enough cash from other sources to repay your debts upon selling your home. And if your home's value declines by 18 percent or more, the lender could possibly lose money considering that the lender owns the rest of your home. Thus, a lower equity means a higher risk for the lender.
Lenders don't like losing money, and they want to provide loans if there's a good guarantee that the loans would bring in some profit rather than losses. To get the most favorable mortgage interest rates, you should maintain a minimum of 20 percent equity in your property and strive to maximize it, whether by paying off your mortgage balance or renovating your home to raise its market value.
Sufficient Cash Reserves
When you have ample money in your savings or checking account, certificates of deposit, or money market funds, lenders will feel more confident that you have the financial backing to continue your monthly house payments even if sudden expenses affect your cash flow. Most lenders requires cash reserves that cover at least two months' worth of house payments, although the requirement may be higher if you're considered a high-risk applicant.
A Down Payment of At Least 20 Percent of the Purchase Price
To get the most enticing mortgage rates, you'll have to save up for a down payment of at least 20 percent of your property's purchase price. Also, this amount of down payment helps you make substantial savings because it eliminates the need to pay for private mortgage insurance.
Shopping for the Best Mortgage Rates
After determining where you stand in terms of qualifying for competitive mortgage rates, your next step is to shop around. Check out reputable online sources to compare the rates offered by various lenders. Many sites feature tools that let you enter details about your desired mortgage and automatically provide a list of the most attractive rates. You may also want to visit your local bank or credit union, as you may have higher chances of bagging low rates and discounts, particularly if you've established a good relationship with them over the years.
Best Fixed Mortgage Rates Available by Positioning Yourself as a Low-Risk Applicant
To gain the trust of mortgage lenders and enjoy a selection of low interest rates, it's important to maintain a good credit score, avoid switching jobs frequently, obtain a higher equity, and save up as much and as often as you can. Try to monitor your credit score regularly and control your spending. It's wise to create a fail-safe plan for sudden expenses and unforeseen situations by building an emergency fund. Mortgage lenders prefer that you keep a good amount of savings instead of using it all up on the down payment, so you won't have to miss payments even if something unexpected comes up. Evaluate your cash flow, existing debts and monthly expenses carefully, and make sure to borrow only what you can afford to pay off. The rule of thumb is that all of your monthly debts should be no higher than 36 percent of your total income pretax.
Make sure to manage your finances wisely from the time you take out a loan until closing on it, as your lender will likely review your credit report to check if there's any significant change in your credit score and history. Maxing out your cards and getting another loan may just derail your mortgage closing. Knowing the major criteria lenders use to determine the appropriate mortgage rates for loan applicants, it's best that you take action immediately and address anything that hampers you from being a well-qualified, low-risk applicant, whether it's about your credit score, amount of debts, cash reserves or total equity.
Hopefully this helps you in finding the best mortgage rates.