Published by Forbes.com | October 28, 2022
If you’re in the market to purchase a home, you know that mortgage rates are rising.
Rates surpassed 7% for the first time in 20 years. And higher mortgage rates send monthly payments up significantly.
A $240,000 mortgage at a 7.544% rate on a 30-year loan generates a monthly principal and interest payment of $1,658. At 3.00%, a rate available not that long ago, the payment was just $1,012. And this raises an important question—how do you get the lowest mortgage rate possible?
Several factors affect mortgage rates, including credit score, loan type and down payment. Here’s a list of five significant factors affecting your mortgage rate, plus actionable tips on how to get the best rate possible.
1. Credit Score
This one is no surprise. Lenders use your FICO score to determine how likely you are to repay a loan. A higher credit score usually results in a better interest rate, all other things being equal. Thus, it’s important to know your credit score and, if necessary, improve it before applying for a mortgage.
2. Loan Type
There are various types of mortgage loans, from fixed-rate to adjustable rate mortgages (ARM) to government-insured loans. Generally, the interest rate for a fixed-rate mortgage may be slightly higher than the rate on an ARM. It can still be the best option as it insulates homeowners from future rate hikes.
3. Debt-to-Income Ratio
Lenders look at your debt-to-income ratio (DTI), or the amount of your monthly debt payments compared to your income. To calculate your DTI, divide your total monthly minimum debt payments by your gross monthly income. Then multiply by 100 to get a percentage. For example, if you have a $1,500 mortgage, $400 car payment, and $200 student loan payment, your monthly debts total $2,100. If you earn $5,000 a month in gross income, your DTI is 42%.
Lenders use DTI as one factor in determining whether to approve the mortgage application. It can also affect the rate you can obtain. Fortunately, there are ways to lower your DTI.
4. Down Payment
The size of the down payment relative to the value of the home affects the monthly payment in at least three ways. First, a down payment of 20% or more eliminates the need for private mortgage insurance (PMI). While the cost of PMI varies, it can add 1% to 2% of the mortgage amount per year.
5. Loan Term
Your loan term, or how long you have to pay back your mortgage, also affects the rate. The two most popular terms are 15-year and 30-year mortgages. The 15-year mortgage generally comes with a lower interest rate.
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