In the past several years, mortgage rates have risen from record lows to the highest in decades. High rates and high housing prices are a tough combination for potential homebuyers. However, even when rates are high, there are ways you can become eligible for lower rates.
Understanding Mortgage Rates
When you take out a loan, mortgages come with interest rates, meaning you'll pay more than the home's cash value. When securing a mortgage, you aim to find the lowest rates possible. The lower the rate, the less you'll pay every month and, therefore, in total.
For example, imagine you're buying a house for $500,000. You're putting $100,000 down; your mortgage is a $400,000 30-year fixed loan. For simplicity, these figures focus only on principal and interest and do not include other costs like property taxes, homeowners insurance, or mortgage insurance.
Consider the following rates based on this example:
| Rate | Monthly Payment (P&I) | Total Interest | Total Cost |
|---|---|---|---|
| 5% | $2,147 | $372,920 | $772,920 |
| 8% | $2,935 | $656,600 | $1,056,600 |
In this example, paying an extra 3% would result in paying $283,680 more than if your mortgage rate were 5%.
Strategies to Lower Your Mortgage Rate
Some factors are beyond your control regarding mortgage rates, such as the Federal Reserve raising rates due to current economic conditions. However, there are some strategies you can implement to ensure you're getting the best mortgage rate available.
- Boost Your Credit Score. A higher credit score can qualify you for lower mortgage rates. To improve your score, make sure to pay bills on time, keep credit card balances low, avoid applying for new credit in the months before applying for a mortgage, and check your credit report for errors.
- Maintain Adequate Cash Reserves. Liquidity in checking, savings, and investment accounts is another positive indicator for lenders, potentially decreasing your mortgage rates. Start saving as much as possible in various accounts. Maintain a solid emergency fund and healthy balances in both savings and investment accounts.
- Keep a Favorable Debt-to-Income Ratio. Lenders will examine your debt-to-income ratio, determining how much of your monthly income goes toward minimum debt payments. A high ratio will lead to a higher mortgage rate or result in lenders declining a loan altogether. For most conventional loans, lenders prefer a DTI ratio below 43%, though some may accept higher ratios under certain conditions.
- Stick to a Monthly Budget Relative to Your Income. The higher your income and flexibility in your budget, the more likely lenders will consider you a low-risk borrower. Never stretch your budget too thin by taking on a mortgage you can barely afford, as financial situations can change.
- Consider Alternative Mortgage Options. While most buyers choose fixed-rate mortgages, some opt for adjustable-rate mortgages, where interest rates fluctuate after an initial fixed period. Since these rates are variable, lenders often offer lower initial fixed-rate periods. This option could save you money compared to a fixed-rate mortgage, though it could also cost you more if rates rise.
- Compare Several Lenders. Don't settle for the first lender you come across. Just as it's smart to look at more than one home, you should shop around for lenders. Aim to get rate quotes from two to four companies, giving you various options. If you do this, ensure you submit preapproval applications within the same month so your credit score isn't negatively impacted.
- Buy Mortgage Points. Purchasing mortgage points is a strategic way to reduce your mortgage costs if you plan to pay it off over a long period. Mortgage points allow you to pay up-front costs to lower your interest rate, potentially saving you money in the long term if you hold the loan long enough.
Timing and Market Considerations
Once you've chosen a lender, lock in your mortgage rate to protect yourself from potential increases before closing. Rate locks typically last 30 to 60 days, though some lenders offer extensions for a fee.
If you aren't in a rush to purchase a home, consider waiting for home prices and rates to decrease. Timing your purchase in line with market conditions could save you money in the long run.
Takeaway
Mortgage rates significantly impact how much you'll pay for your home. Even a small difference in your mortgage rate can lead to substantial savings. Take the time to ensure you're getting the best rate available, and always ensure the mortgage you choose is one you can comfortably repay.