Why Mortgage Interest Rates Matter
Mortgage interest rates impact more than just the monthly amount you’ll pay—they determine the total cost of borrowing money for a home. Interest is what you pay in exchange for borrowing funds to buy a house, and mortgage lenders set this rate based on various factors, including the type of loan, market conditions, and your financial profile. A mortgage interest rate can seem small, but over 30 years, even a difference of 0.25% can save you thousands of dollars. Understanding what influences these rates helps you make better choices and save money.Tip 1: Make Your Comparisons on the Same Day
Mortgage interest rates change frequently, sometimes even multiple times in a single day. Rates fluctuate due to market conditions, including inflation, economic indicators, and the bond market. To get an accurate sense of what’s available, it’s essential to contact multiple mortgage lenders on the same day. Consider contacting at least three types of lenders, such as:- Local banks: They often provide competitive rates for community members and sometimes offer special deals.
- Mortgage brokers: They work with multiple lenders and may offer a broader range of options and potentially lower rates.
- National banks or credit unions: They may offer specialized programs or lower fees, which could reduce your total mortgage cost.
Tip 2: Ask About Each Lender’s Debt-to-Income Ratio Requirements
The debt-to-income (DTI) ratio is a vital part of how lenders assess a borrower’s financial health. It represents the portion of your monthly income that goes toward paying debts. For example, if you earn $6,000 per month and have monthly debt payments of $2,000, your DTI ratio is about 33%. Lenders use DTI ratios to ensure that borrowers aren’t taking on more debt than they can comfortably handle. Generally, a lower DTI ratio can qualify you for a better mortgage interest rate, as it shows you have room in your budget to take on new debt. Here’s how DTI ratio requirements may vary:- Conventional Loans: These usually have a DTI limit of about 45% to 50%, depending on other factors like credit score and down payment.
- FHA Loans: For government-backed loans like FHA, the DTI limit may extend up to 56%, but a high DTI could mean a higher interest rate.
- VA Loans: The VA (Veterans Affairs) loan program typically allows a higher DTI ratio for qualified veterans, potentially up to 60%.
Tip 3: Discover Each Lender’s Rate Lock Period to Choose the Right Time to Lock
Interest rates fluctuate regularly, so a rate lock is a feature that lets you lock in the rate you were quoted, protecting you from rate increases during the loan process. Rate locks typically last between 30 and 60 days, but longer periods may be available for an additional cost. Why does a rate lock matter?- Protects against rate increases: If rates rise while you’re finalizing your loan, the lock secures the lower rate for you.
- Helps with budgeting: Knowing your exact rate means you’ll have a more predictable monthly payment amount.
- Watch the market: Some lenders may provide insight into current market trends, which can help you decide whether to lock in the rate immediately or wait.
- Get your documents ready: Aim to have your paperwork prepared in case you need to move quickly on a rate lock.
- Ask about extensions: If you need extra time, see if your lender offers a rate lock extension and any associated fees.
Tip 4: Understand the Impact of Your Credit Score
Your credit score is one of the biggest factors lenders use to set your interest rate. Mortgage lenders look at each applicant's credit score, even if you’re applying jointly with a co-applicant. Lenders will pull credit reports from the three major credit bureaus—Experian, Equifax, and TransUnion—and typically use the middle score for mortgage applications. For example, if you have scores of 720, 705, and 710, they will use 710 as your qualifying score. Why your credit score matters:- Higher scores mean lower rates: Typically, a score of 740 or above qualifies for the best rates, though minimum scores vary by lender and loan type.
- Different loans have different requirements: For example, FHA loans have a minimum score requirement of around 580 for lower down payments, while conventional loans often require a higher score to get the best rates.
- Co-applicants can impact the rate: If you’re applying with a co-borrower with a lower credit score, it can raise the rate offered, as lenders use the lowest qualifying score between the two borrowers.
Additional Tips for a Smooth Rate Shopping Experience
Aside from these main tips, here are a few additional points to make your rate shopping process smoother:- Prepare your financial documents: Lenders will often require documentation like pay stubs, bank statements, and tax returns. Having these ready speeds up the process and prevents delays.
- Ask about points: Points, or “discount points,” are upfront payments you can make to “buy down” your interest rate. One point usually costs 1% of the loan amount and can lower your rate by about 0.25%. If you have extra funds and plan to stay in your home long-term, buying points could save you money over time.
- Know your down payment options: Your down payment amount influences your interest rate. For instance, a larger down payment might qualify you for a lower rate, as it reduces the lender's risk.
- Use a mortgage calculator: These online tools allow you to input different rates and loan amounts to see the effect on monthly payments, helping you visualize the impact of various rates on your budget.