Are you ready to apply for a mortgage to finance a home purchase? If so, there’s plenty to think about, including ensuring that you get the lowest interest rate possible. The overall affordability of your mortgage has a lot to do with the interest rate you’re charged.
Even one percent difference can mean the difference of tens of thousands of dollars over the life of your loan. So if you want to save money on your mortgage, your best bet is to try to get the lowest rate possible, and here are some effective ways to do just that.
1. Boost Your Credit Score
One of the most important factors that influences your mortgage interest rate – and whether or not you’ll be able to get approved for a mortgage at all – is your credit score. This number paints a picture of the type of borrower you will be for your lender and will assess your risk level. Generally speaking, a low credit score tells lenders that you haven’t been financially responsible in the past, and that includes possibly missing bill payments.
On the other hand, a higher credit score likely means you’ve been diligent about making bill payments on time every month and have been using credit wisely. If you want to increase the chances of getting a lower interest rate on your mortgage, make sure your credit score is as high as it can be. To do that, you can adopt any one of the following habits:
- Pay all bills on time and in full every month
- Don’t spend more than 30% of your credit card limit
- Make more than your minimum monthly credit card payments
- Don’t apply for too many loans or credit products in a short time frame
- Pay down your debt
2. Consider an Adjustable-Rate Mortgage
Generally speaking, adjustable-rate mortgages (ARMs) come with lower mortgage rates during the introductory period compared to fixed-rate mortgages. If you are planning to sell your home within five years of moving into it, an adjustable-rate mortgage might be an effective way to snag a lower interest rate.
A 5/1 ARM, for instance, will start off with a lower interest rate period at the beginning. The rate will then fluctuate at various intervals based on the interest rate environment at the time. This type of mortgage begins with a fixed rate for the first five years, and then becomes an adjustable-rate mortgage for the rest of the term. A year after the initial introductory five-year period has ended, the interest rate will be adjusted, either up or down, depending on several factors.
As mentioned, if your plan is to sell within five years, you can take advantage of this initial low-rate term to make your mortgage more affordable.
3. Take Out a Shorter-Term Mortgage
The interest rate that your lender offers you will depend on a number of factors, including the term on your mortgage. Generally speaking, a shorter-term loan will come with a lower interest rate. Since you will be tasked with paying off your entire loan amount in a shorter period of time compared to a longer-term loan, there is inherently less risk to the lender that the full loan amount won’t be entirely repaid.
4. Boost Your Down Payment Amount
If you can save up for long enough to put down a sizable down payment amount, you may be able to score a lower interest rate on your mortgage. A higher down payment will mean you’ll be able to take a smaller loan out on your home. And a smaller loan amount not only makes it cheaper for you at the end of the day, but it also lowers your risk for default, as well as your lender’s risk.
To compensate for this reduced risk on the part of the lender, you may be rewarded with a lower interest rate on your mortgage. A higher down payment amount mitigates any risk that lenders take on when they loan out funds to finance a home purchase, which means a lower rate for you. Not only that, but you’ll also get to take advantage of more equity in your home right off the bat with a higher down payment amount.
A larger down payment also means that your lender will be more likely recoup the funds loaned out in case you do end up foreclosing on your home. In this unfortunate case, your lender will be able to get back more money when the home sells if there’s less that still needs to be paid into it. As such, lenders are more willing to offer a lower interest rate.
5. Take Out a Lower Loan Amount
While there’s little that you can do to influence the prices of homes these days, you can lower your loan amount by either putting forth a higher down payment amount (as already discussed), or choosing a home with a lower price tag. The latter tactic may require that you either look at different housing options homes or look slightly outside more expensive city centers.
Either way, a smaller loan amount typically translates into a lower interest rate. More specifically, if you can keep your mortgage as a conforming loan as opposed to taking out a jumbo loan, you may be able to lower the interest rate that your lender offers you. Conforming loan limits vary from one state and county to the next, so you’d be well advised to find out what the limit is in your particular area. That way you’ll know for sure whether or not you’re able to stay below if and therefore take advantage of a lower interest rate.
6. Pay Down Your Debt
We mentioned that your credit score plays a key role in your ability to both secure a mortgage and get a lower rate. But another important factor that lenders consider is your debt-to-income ratio, which is essentially your debt relative to your income. More specifically, it’s a measure of your monthly debt obligations and the amount of monthly income that is dedicated to paying the debts.
The higher your debt-to-income ratio, the more debt you have relative to how much you earn, which can make it more difficult for you to not only get a lower interest rate, but also get approved for a mortgage. To help boost your odds of getting a lower interest rate, consider paying down your debt as much as possible before applying for a home loan.
If time is on your side, do what you can to reduce your debt load in order to lower your debt-to-income ratio, free up more money to put towards your mortgage, and lower your interest rate.
7. Comparison Shop With Different Lenders
Different lenders may have different mortgage rates that they offer their clients. It may be worth it to shop around with different lenders to see what they are able to offer. Keep in mind, however, that much of what lenders can offer you comes down to your financial profile. So the better your financial health, the more likely lenders will offer you a lower interest rate.
As mentioned, a lower rate can save you a ton of money over the life of your loan. If you’re in the market to shop around for a mortgage, consider adopting the above-mentioned tips to help ensure you get the lowest interest rate possible on your mortgage.