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It’s a good idea to comparison-shop for the best mortgage rate you can get, because even a small rate difference can mean tens of thousands of dollars in savings. (iStock)
Buying a home is one of the biggest financial decisions you’ll make in your life. And choosing the right mortgage is one of the most important parts of the homebuying process.
Mortgages come in all shapes and sizes, and interest rates can vary widely from lender to lender. The interest rate represents the price of borrowing money — and even a small difference in rate can equal a drastic difference in your total costs.
For example, if you take a 30-year, fixed-rate mortgage with a 3% interest rate, your monthly payment will be $843, and you’ll pay $103,555 in interest over the life of the loan. But that same loan with a 5% interest rate will cost you $1,074 per month and $186,512 in interest costs.
Just a 2% difference in your interest rate adds up to nearly $83,000 in additional interest charges over the loan term.
So as you shop for a mortgage, you want to make sure you get the best mortgage rate. Here are nine tips to help you do just that, and save money on your mortgage in other ways.
1. Use a mortgage calculator
Mortgages are complex, and even small changes in their terms can significantly affect your total costs. A good first step toward understanding your future mortgage is to try out a mortgage calculator. Available online, a good mortgage calculator will allow you to tweak the interest rate and terms of a mortgage and see how that affects the monthly payment and overall costs. It can also help you get a sense of how much you’ll be able to afford.
You can compare mortgage rates from multiple lenders through Credible.
2. Improve your credit score
Your credit score plays a major role in determining the mortgage rate you’ll be offered. Lenders view credit scores as representative of how likely you are to repay a loan. The higher your score, the better the interest rate you’re likely to receive.
Many lenders also have minimum credit scores to qualify for a conventional mortgage. You’ll need a score of at least 620 to get most conventional mortgages, and a score of 580 or higher to get the lowest down payment requirement on an FHA loan.
The best mortgage rates, however, go to people with credit scores in the mid-700s or higher. If your score is lower than that, you might consider focusing on improving your score before applying for a mortgage.
Request copies of your credit report from the three major credit bureaus using a site like AnnualCreditReport.com (you’re owed a free copy each year). Look through them to see if there are any errors you should dispute. Commit yourself to paying all your bills on time, paying down debts, and staying well below the credit limit on your credit cards.
3. Reduce your debt-to-income ratio
Your "debt-to-income (DTI) ratio" is a key metric lenders use when evaluating mortgage applications. DTI measures all your monthly obligations compared to how much money you make. Lenders consider DTI to see if you’ll be able to handle your monthly mortgage payment.
A higher debt-to-income ratio could mean you’re more likely to struggle with mortgage payments. A ratio of 43% or higher (including your potential mortgage payment) is considered risky, and a ratio of 50% is the maximum for many types of mortgages, including those from Fannie Mae.
Paying down your debt can make it more likely you’ll qualify for a mortgage and get a better rate. Consider spending some time reducing the balance on your credit cards or paying off loans before applying for a mortgage.
4. Research homebuying assistance programs
A multitude of state and federal programs can help you afford a home, particularly if you’re a first-time homebuyer. Federal programs include:
- FHA loans. These loans, insured by the Department of Housing and Urban Development (HUD), help people with lower credit scores qualify for a mortgage with a low down payment.
- VA loans. Eligible service members and veterans may qualify for a mortgage with zero down payment.
- USDA loans. People in rural areas may qualify for fixed-rate, lower-cost mortgages with zero down payment.
- Homeownership vouchers. These are available to qualifying low-income people needing help buying a home.
States often have more robust first-time homebuyer programs, which can include down payment assistance. Contact your state housing finance agency or a HUD field office for more information on these programs. Your lender may be able to help you find them as well.
5. Make a down payment of at least 20% to avoid PMI
Some lenders and types of loans allow you to buy a home with a small down payment. But if you put less than 20% down on a property, you’ll need to buy private mortgage insurance.
Commonly referred to as PMI, private mortgage insurance protects your lender if you fail to make your mortgage payments. Typically, you’ll pay a monthly PMI premium as part of your regular mortgage payment until you qualify to drop the insurance.
PMI monthly premiums range between $30 to $70 for every $100,000 you borrow, according to Freddie Mac. So if you want to buy a $250,000 house, put 10% down ($25,000) and finance the rest ($225,000), your monthly PMI payment would be at least $60, but could end up north of $140.
Because PMI represents an additional cost, saving up to make a 20% down payment can help you save money down the road.
6. Choose a shorter loan term length
A 30-year mortgage may be the most common, but you have multiple options when it comes to the length of your mortgage loan. Mortgage lenders typically offer 10-year, 15-year, or 20-year mortgages as well.
The shorter the length of your mortgage, the higher your monthly payment tends to be. But you’ll also get lower mortgage rates and pay significantly less in interest over the life of the loan. If you can afford the higher monthly payment, you’ll save a lot of money in the long term with a shorter term length.
Credible makes it easy to compare mortgage rates for different terms from multiple lenders.
7. Select the best type of mortgage for you
Different mortgage products work better for people with different financial situations. Here are the most common types of mortgage loans:
- Conventional loans. This category of loans refers to mortgages that aren’t part of any particular government program. Most of the time, they’re known as "conforming" loans that adhere to rules set by the Federal Housing Finance Agency. These loans tend to be best for people with good credit looking for low mortgage rates.
- Jumbo loans. These loans are bigger than the limits set for conforming loans ($548,250 in 2021). Jumbo loans can be as large as $1 million or more.
- FHA loans. These mortgages come from private lenders but are insured by the federal government, allowing people who might not otherwise qualify for a mortgage to buy a home. They can be great for people who don’t qualify for a conventional loan, but can be more expensive in the long run.
- VA loans. These mortgages are a benefit the Department of Veterans Affairs provides to service members and veterans. Qualifying borrowers can buy a home with no down payment.
- USDA loans. These programs from the U.S. Department of Agriculture either lend money directly to low-income people in rural areas or insure loans from private lenders. They offer no-down-payment loans to people who qualify.
8. Consider paying for interest point reductions up front
When you pay points at your mortgage closing, you’re essentially paying a fee in exchange for a lower interest rate. Your lender may also refer to these as discount points, mortgage points, or prepaid interest.
One point is generally 1% of the loan amount. The amount each point reduces your interest rate depends on the lender.
Paying points makes the most sense when you know you’ll be in the home for a longer period of time. It takes time for the reduced interest rate and lower monthly payment to recoup the money you pay up front for points.
9. Shop for rates
It’s good practice to compare at least five different loan estimates to find the best rate. Doing so can save you an average of $3,000, according to Freddie Mac.
Using a service like Credible can make rate-shopping simpler. You just have to fill out your information once and can then check rates with multiple lenders.
As you’re evaluating different loan offers, make sure you pay attention to more than just mortgage rates. Also look at fees, closing costs, and other charges that can affect the amount you pay overall.
Because there are so many costs associated with buying a home and getting a mortgage, it’s a good idea to compare APRs from different lenders, too. APR incorporates the interest rate and all the other costs of the mortgage, so it can be a better picture of the total cost of a loan.