As the federal reserve made adjustments in response to rising inflation, mortgage rates have gone from rates in the 3% range to the 7% range. Experts are divided when it comes to predicting where rates are headed next.
Regardless of economic conditions, there are always people that are ready to buy and sell homes. Thus, I advise my clients that regardless of issues outside of their control, they do have control over measures they can undertake that can make a difference in securing the lowest mortgage rate. With some planning, you can work toward qualifying for the best mortgage rates available today and open up the possibility of refinancing at a lower rate in the future.
How does a lower mortgage rate save you money? According to Trading Economics, the average new mortgage size in the United States is currently around $410,000.2 Let’s compare a 5.0%, 6.0%, and 7.0% fixed interest rate on that amount over a 30-year term with only a 5% down payment.
| Mortgage Rate (30-year fixed) | Monthly Payment on $410,000 Loan (excludes taxes, insurance, etc.) | Difference in Monthly Payment |
|---|---|---|
| 5.0% | $2,090 | |
| 6.0% | $2,335 | + $245 |
| 7.0% | $2,591 | + $256 |
With a 5% rate, your monthly payments would be about $2,090. At 6%, those payments would jump to $2,335, or around $245 more. At 7%, your payment would rise to $2,591. The good news is that experts predict that once inflation settles back down, historically interest rates drop. Refinancing back down by just 1 percentage point reduces your payment dramatically.
So, how can you improve your chances of securing a low mortgage rate and later refinancing? Try these eight strategies:
1. Raise Your Credit Score.
The higher your credit score, the less risky a borrower is viewed. Borrowers with the highest scores are offered the lowest interest rates. A good credit score typically starts at 690 and can move up into the 800s.3 If you don’t know your score, check with your bank or credit card company to see if they offer free access. If not, there are several free and paid credit monitoring services you can utilize.If Your Credit Score Needs Improvement, Consider Pursuing the Following:
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Correct any errors on your credit reports, which can bring down your score. You can access reports for free by visiting AnnualCreditReport.com.
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Pay down revolving debt. This includes credit card balances and home equity lines of credit.
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Avoid closing old credit card accounts in good standing. It could lower your score by shortening your credit history and shrinking your total available credit.
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Maintain making all your future payments on time. Payment history is a primary factor in determining your credit score, so make it a top priority.
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Limit applying for credit as credit inquiries will reduce your credit score. If you’re shopping around for a car loan or mortgage, minimize the impact by limiting your applications to a short period, usually 14 to 45 days.5
Making positive impacts on the above will begin to raise your credit score over time which will help you qualify for a lower mortgage rate.
2. Maintain Steady Employment.
If you are preparing to purchase a home, it is not the best time to make a major career change. Frequent job moves or gaps can hurt your borrower eligibility.
When you apply for a mortgage, lenders will typically review your employment and income over the past 24 months.5 If you’ve earned a steady paycheck, you could qualify for a better interest rate. Lenders seek a stable employment history which gives them confidence that you have the ability and likelihood to repay the loan.
Not all job changes will cause an issue, especially if you remain in the same industry and similar job title. Discuss with your lender before you make any house-hunting plans. A major change like switching from W-2 to 1099 (independent contractor) income, could impact your eligibility.
3. Lower Your Debt-To-Income Ratios.
Even with a high credit score and a great job, lenders also consider whether your debt payments are consuming too much of your income. That’s where your debt-to-income (DTI) ratios will come into play.
There Are Two Types of Dti Ratios:
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Front-end ratio. What percentage of your gross monthly income will go towards covering housing expenses (mortgage, taxes, insurance, and dues or association fees)?
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Back-end ratio. What percentage of your gross monthly income will go towards covering ALL debt obligations (housing expenses, credit cards, student loans, and other debt)?
What’s considered a good DTI ratio? For better rates, lenders typically want to see a front-end DTI ratio that’s no higher than 28% and a back-end ratio that’s 36% or less.
If your DTI ratios are higher, consider purchasing a less expensive home or increasing your down payment. Your back-end ratio can also be decreased by paying down your existing debt. An increase in your monthly income will also bring down your DTI ratios.
4. Increase Your Down Payment.
Minimum down payment requirements vary by loan type. But, in some cases, you can qualify for a lower mortgage rate if you make a larger down payment.
Why do lenders care about your down payment size? Because borrowers with significant equity in their homes are less likely to default on their mortgages. That’s why conventional lenders often require borrowers to purchase private mortgage insurance (PMI) if they put down less than 20%.
A larger down payment will also lower your overall borrowing costs and decrease your monthly mortgage payment since you’ll be taking out a smaller loan. Just be sure to keep enough cash on hand to cover closing costs, moving expenses, and any furniture or other items you’ll need to get settled into your new space.
5. Compare Loan Products.
All mortgages offer different pros and cons. The loan type you choose could save (or cost) you money depending on your qualifications and circumstances.
These are the most common loan types available in the U.S. today:
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Conventional — These offer lower mortgage rates but have more stringent credit and down payment requirements than some other types.
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FHA — Backed by the government, these loans are easier to qualify for but often charge a higher interest rate.
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Specialty — Certain specialty loans, like VA or USDA loans, might be available if you or the property meet specific criteria.
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Jumbo — Mortgages that exceed the local conforming loan limit are subject to stricter requirements and may have higher interest rates and fees.10
When considering loan type, you’ll also want to weigh the pros and cons of a fixed-rate versus variable-rate mortgage:
- Fixed-rate. With a fixed-rate mortgage, you’re guaranteed to keep the same interest rate for the entire life of the loan. Traditionally, these have been the most popular type of mortgage in the U.S. because they offer stability and predictability.
- Adjustable rate. Adjustable-rate mortgages, or ARMs, have a lower introductory interest rate than fixed-rate mortgages, but the rate can rise after a set period of time typically 3 to 10 years.
According to the Mortgage Bankers Association, 10% of American homebuyers are now selecting ARMs, up from just 4% at the start of this year.12 An ARM might be a good option if you plan to sell your home before the rate resets. However, life is unpredictable, so it’s important to weigh the benefits and risks involved.
6. Shorten Your Mortgage Term.
A mortgage term is the length of time your mortgage agreement is in effect. The terms are typically 15, 20, or 30 years.13 Although the majority of homebuyers choose 30-year terms, if your goal is to minimize the amount you pay in interest, you should crunch the numbers on a 15-year or 20-year mortgage.
With shorter loan terms, the risk of default is less, so lenders typically offer lower interest rates.13 However, it’s important to note that even though you’ll pay less interest, your mortgage payment will be higher each month, since you’ll be making fewer total payments. So before you agree to a shorter term, make sure you have enough room in your budget to comfortably afford the larger payment.
7. Get Quotes from Multiple Lenders.
When shopping for a mortgage, be sure to seek quotes from several different lenders and lenders types to compare the interest rates and closing costs. Depending upon your situation, you could find that one institution offers a better deal for the type of loan and term length you want.
Some borrowers choose to work with a mortgage broker. Like an insurance broker, they can help you gather quotes and find the best rate. However, if you use a broker, make sure you understand how they are compensated and contact more than one so you can compare their recommendations and fees.
Don’t forget that I can be a great resource in finding a local lender, especially if you want to shop all your best options. After a consultation, we can discuss your financing needs and connect you with loan officers or brokers best suited for your situation.
8. Consider Paying Mortgage Points.
Even if you are offered a great interest rate on your mortgage, you can lower it even further by paying for points. When you buy mortgage points — also known as discount points — you essentially pay your lender an upfront fee in exchange for a lower interest rate. The cost to purchase a point is 1% of your mortgage amount. For each point you buy, your mortgage rate will decrease by a set amount, typically 0.25%.15 You’ll need upfront cash to pay for the points, but you can more than makeup for the cost in interest savings over time.
However, it only makes sense to buy mortgage points if you plan to stay in the home long enough to recoup the cost. You can determine the breakeven point or the period of time you’d need to keep the mortgage to make up for the fee, by dividing the cost by the amount saved each month.15 This can help you determine whether or not mortgage points would be a good investment for you.
Getting Started
Don’t expect that interest rates will return to the rock-bottom levels of the 2-3% range that we saw during the pandemic. Those rates were kept artificially low to keep our economy stable during the pandemic.
Many of us don’t realize that even today’s 30-year fixed rates still fall beneath the historical average of around 8% — and are well below the all-time peak of 18.45% in 1981.
No doubt that higher mortgage rates have made it more expensive to finance a home purchase, but they have also created a necessary market shift. Home prices are not rising as rapidly as in the past and in the short term, we are not experiencing the highly intensive competitive market that made it difficult to buy a home. Today’s buyers are finding more homes to choose from, facing fewer bidding wars, and more sellers are willing to negotiate or offer incentives such as cash toward closing costs or mortgage points.
If you’re ready and able to buy a home, don’t let concerns about mortgage rates derail your plans. The reality is that many economists predict home prices to continue climbing because we remain in a housing shortage for the foreseeable future.18 You may be better off buying today at a slightly higher rate than waiting and paying more for a home a few years from now. You can always refinance if mortgage rates go down, but you can’t make up for the lost years of equity growth and appreciation.
If you have questions or would like more information about buying or selling a home, reach out to schedule a free consultation. I’d love to help you weigh your options, discuss this shifting market, and reach your real estate goals!
