If you’re in the market to buy a house, you probably see dozens of advertisements from lenders trumpeting interest rates that seem impossibly low.
Actually those are real rates—but they are reserved for a very elite few borrowers with the best credit, the largest down payments, and the ability to qualify for pretty much any loan amount. The rest of us never see those kinds of rates.
Many factors determine the rates lenders charge. These include their cost of money, which is a function of a long list of factors ranging from the prime rate that the Federal Reserve charges banks to the cost of money in the global economy. The amount they want to make on the loan, the risk each borrower presents, and even the lender’s location all impact the actual rate that the lender will quote you when you apply for a loan.
You can’t do much about these factors, which is why it is wise to shop around widely for a lender. After all, you are about to take out the biggest loan of your life. However, there are a number of factors that determine your interest rate that you CAN do something about.
Knowing what they are and know how to influence them can save you hundreds of thousands over the life of your mortgage.
1. Credit score
Your credit score helps lenders predict how reliable you’ll be in paying off your loan. Your credit score is calculated from your credit report, which shows your payment history on loans and debt over the past seven years.
Other factors, such as the amount of credit you can access and recent requests for credit reports from lenders, also impact your credit score. In general, if you have a higher credit score, you’ll be able to get a lower interest rate.
Before you begin shopping for a home, review your credit report carefully. Clean up errors. Make sure you pay every bill promptly and don’t take out credit cards or lines of credit that you don’t need. If you have too much credit, pay off some of your cards and close the accounts. Avoid applying for new credit until after you close on your home.
Only apply for your mortgage with lenders you have researched and are serious about; every time your credit history is pulled, even if you never do business with the lender who makes the inquiry, it hurts your credit rating
2. Loan amount
Typically, you’ll pay a higher interest rate if you’re taking out a particularly small or particularly large loan. If your loan exceeds the loan limits for FHA, Fannie Mae and Freddie Mac, you will have to take out a jumbo loan, which could raise your rate by several points.
In 2015, the loan limits for single family homes range from $417,000 to $625,000, depending on location. Just because you are pre-approved by a lender to borrow a large amount, be prepared to pay a higher rate if you decide to borrow the maximum.
As a general rule, it is not wise to end up with a mortgage at the upper limits of your pre-qualified or pre-approved ceiling. You are taking more risk in a depressed market, like the one that hit in 2007, you could find yourself “house poor” and under-equitied, leaving yourself vulnerable to foreclosure.
3. Down Payment
The amount of your down payment affects your interest rate because larger down payments lower the amount of the loan and, therefore, lower the risk that the lender incurs.
Lenders will reward larger down payments with better rates; they want borrowers who are willing to put a larger personal stake in the property. So if you can put 20 percent or more down, do it—you’ll usually get a lower interest rate. You will also pay less interest over the life of the mortgage.
4. Loan Terms
Shorter term loans have lower interest rates and lower overall costs but higher monthly payments. Interest rates come in two basic types: fixed and adjustable.
Fixed interest rates don’t change over time but adjustable rates have an initial period—usually five to seven years–that is lower than a fixed rate. At the end of the initial period, they “reset” and fluctuate based on market factors.
5. Loan Type
You may have wider variety of loans from which to choose than you realize and these may have different interest rates. If you are a veteran, you may qualify for a VA loan. An FHA loan will get you a lower down payment than a conventional loan because the government is taking on most of the risk.
Many state and municipal housing authorities offer loans similar to FHA loans at lower down payments and rates than commercial lenders. Most have income limits and some down payment assistance programs are limited to first-time home buyers.
6. Timing and Locking
In mortgages, timing is everything. Mortgage rates can change quickly and missing a “bottom” as interest rates change can cost you a lot over the life of a mortgage. Follow the financial news carefully. Try to time your house search to correspond with changes in rates. If you think rates are going to rise, act quickly. If they are falling, take hour time until you think they won’t fall further.
When your loan application is approved, lenders are obligated to offer you an agreed-upon rate regardless of whether mortgage rates have changed between the time of the loan approval and the closing date.
However, many lenders will let your rate continue to float until you close so that you can lock in the best rate during the lock-in period. A rate lock is a guarantee from a mortgage lender that they will give a mortgage loan applicant a certain interest rate, at a certain price, for a specific time period.
The price for a mortgage loan is typically expressed as “points” paid to obtain a specific interest rate. (Points are basically prepaid interest, so the more points you pay, the lower the interest rate; 1 point equals 1 percent of the loan amount.) Locked in rates are good for 30, 45 or 60 days and can be extended if closing takes longer.