Get some tips on how to compare mortgage products, understand how paying points works, and learn ways to improve your financial situation so you can score the most competitive rates.
Shop Around
Wondering how to find the best mortgage rate? Shopping around is key, especially with a purchase as large as a home. You’ll want to get a few different loan preapproval letters so you can compare rates and make sure you’re getting the best loan for your situation. You have a couple of options:
Use a mortgage broker. A broker knows how to find the best mortgage rate and can present you with several offers at once. Just be mindful that they technically work for the lenders and that you will pay a broker fee, so do your due diligence. Request quotes on your own. Once you’re serious about moving forward, you can fill out a few loan applications (allowing lenders to perform a hard credit check) to get preapproval letters. These will outline how much you can borrow as well as your approved interest rate. Just remember that there’s a more in-depth application review that comes later on, so a preapproval is not a guarantee.
Once you have a few quotes, look at each one’s interest rates and annual percentage rates (APR). APR includes most of the fees you would pay, including loan origination, mortgage insurance, some closing costs, and discount points, so you have a more accurate picture of the total loan cost. In other words, just because one loan has a lower interest rate doesn’t automatically make it the better deal. That said, the mortgage interest rate is what determines how much you’ll pay monthly, so it’s still a crucial part of your decision. Ultimately, looking at APR vs. interest rate helps you think about how much you’re willing to pay upfront as well as differences in your monthly payment.
Compare Mortgage Products
When shopping around, keep in mind that different types of mortgages are available. The classic, fixed 30-year conventional mortgage may be the most popular (accounting for 78% of closed loans in December 2021), but it may not necessarily be the best option for every consumer. Here are mortgage types to consider:
Different Terms
The longer the term, the higher the interest rate, but the smaller the monthly payment. But shorter-term mortgages come with lower rates, meaning you’ll pay less in interest over the life of the loan. For some consumers who can afford a higher monthly payment, it might make sense to explore a 15-year mortgage. Some lenders may also offer 20-year loans or loans with other terms.
Fixed- vs. Adjustable-Rate Mortgages (ARM)
For homebuyers who prefer to have the same principal and interest payment over the entire course of their mortgage, a fixed-rate loan is the way to go. For a subset of buyers who are less risk averse, an adjustable-rate mortgage might be more attractive. That’s because ARMs usually start off with a rate that is lower than fixed-rate loans. However, the rate will fluctuate (higher or lower) at set points in time. If you only plan to stay in a home for a short period, an ARM could be a money-saving move.
Conventional vs. Government-Backed Loans
Conventional loans and government-backed loans like FHA, VA, or USDA loans each have pros and cons. When it comes to interest, government-backed loan programs will sometimes have more competitive rates since there is less risk to the lender. However, government-backed loans also have other factors to consider, such as upfront fees and mortgage insurance costs; different credit score, income, and/or military service requirements; and limitations on the type of home or home location.
Improve Your Financial Situation
Now that you have a good idea of the loans available, it’s time to put your best financial foot forward. Because your interest rate is highly dependent on where you stand credit-wise and from an income and debt perspective, it is within your control—and your best interest (pardon the pun)—to give your personal finances a makeover before you go home shopping.
Boost Your Credit Score
Credit score is one of the key factors that lenders consider when setting your mortgage rate. From their perspective, those with stronger credit are less likely to default on their loan, and therefore, those borrowers qualify for lower interest rates. If you’re in the market for a home loan, you should keep regular tabs on your credit score, which is commonly offered for free via your credit card or bank accounts. You should also pull your credit reports from the three credit bureaus (Experian, Equifax, and Transunion) for free via annualcreditreport.com. Those will give you a more detailed picture of what may be bringing your score down. The good news is that a higher credit score is attainable. First and foremost, you need to pay your bills each month on time since payment history is the biggest component of the credit score calculation. The next biggest factor is utilization, or how much you owe relative to your available credit. In other words, paying down your balances can increase your score. There are more advanced methods for improving your credit as well; a credit counselor or financial advisor can help guide you.
Reduce Your Debt
Your debt-to-income (DTI) ratio is the other major criteria mortgage lenders consider to determine your rate. This refers to the percentage of your income that is needed to pay for your debt each month. In general, conventional loans require a DTI of 36% or less, although lenders may allow up to 45% if borrowers meet a higher credit and cash reserve threshold. FHA loans require a DTI of 43% or lower, while the maximum for VA loans is 41%. You can improve your DTI by lowering the amount of debt you owe. If you can do so, it will put you in a more favorable position to qualify for a lower mortgage interest rate.
Increase Your Income
The other component of DTI is income, so if you can earn more, that will also improve your ratio. Asking for a raise is one way to increase your income before applying for a loan. You might also take on more overtime or work a side gig.
Save for a Larger Down Payment
Putting more money down on a home—aka lowering your loan-to-value ratio (LTV)—means a smaller loan amount and therefore less risk to the lender. If you can manage it, an LTV of 80% or less (i.e., putting 20% or more down on the home) will mean that you don’t have to pay private mortgage insurance (PMI). Saving for a down payment requires diligence and time; just try not to fully deplete your cash reserves because you’ll need some money in the bank for future expenses.
Pay Points To Lower Your Rate
Another way to lower your rate is to pay discount points. Usually, one point costs 1% of your loan, and each point you pay typically drops your interest rate down by 0.25% (the exact reduction amount will vary by lender). So on a $300,000 loan with a 4% interest rate, if you paid for two points, it would cost $6,000 upfront, and you’d lower your rate to 3.5%. It’s important to crunch the numbers to see if paying points is worth it for you.
The Bottom Line
Finding the best mortgage rate is more than just timing the market. The amount of research you put in and your ability to improve your financial status can have a huge impact on the rate that you ultimately pay. If you have time on your side, use it wisely to shop lenders, explore different loan programs, and improve your credit, income, and debt profile to position yourself for the best rate available. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
