8 Steps to get the Best Mortgage Rates

Ready to learn how to get the lowest possible mortgage rate? Follow this eight-step process...

1. Improve your credit score

Boosting your credit score is a great first step to getting a lower mortgage interest rate. 

“A credit score is always an important factor in determining risk,” says Valerie Saunders, past president of the National Association of Mortgage Brokers (NAMB). “A lender is going to use the score as a benchmark in deciding a person’s ability to repay the debt. The higher the score, the higher the likelihood that the borrower will not default.”

To be considered for a conventional mortgage, you’ll generally need a score of 620 or higher. However, the best mortgage rates go to borrowers with credit scores of 740 or above.

To improve your score, pay your bills on time and pay down or eliminate credit card balances. If you must carry a balance, make sure it’s no more than 20 percent to 30 percent of your available credit limit. Also, check your credit score and report regularly and look for any mistakes. If you find errors, correct them before applying for a mortgage.

2. Build a steady employment record

Lenders prefer you to have at least two years of steady employment and earnings, ideally from the same employer. Be prepared to show pay stubs from at least 30 days prior to your mortgage application and W-2s from the past two years. If you earn bonuses or commissions, you’ll need to provide proof of those, as well.

It can be more difficult to qualify if you’re self-employed or have multiple part-time jobs, but it’s not impossible. If you’re self-employed, you might need to furnish business records, such as profit and loss statements, in addition to tax returns, to round out your mortgage application.

What if you’re a graduate just starting your career, or you’re back in the workforce after time away? Lenders can usually verify your employment if you have a formal job offer in hand, so long as the offer includes your income. The same applies if you’re currently employed but have a new job lined up. Lenders might flag your application if you’re switching to a completely new industry, however.

Gaps in your work history won’t necessarily disqualify you, but the length of those gaps matters. A short period of unemployment due to illness is easier to explain to a lender than, say, unemployment of six months or more. 

3. Save up for a down payment

Putting more money down — ideally, at least 20 percent — can help you get a lower mortgage rate. Of course, lenders accept lower down payments, but putting down less than 20 percent usually means you’ll pay a higher mortgage rate, and you’ll have to pay private mortgage insurance (PMI). PMI costs about $30 to $70 per month for every $100,000 borrowed, according to Freddie Mac. The sooner you can pay down your mortgage to less than 80 percent of the total value of your home, the sooner you can get rid of mortgage insurance, reducing your monthly bill.

4. Understand your debt-to-income ratio

Your debt-to-income (DTI) ratio compares your total monthly debt payments to your gross monthly income.

In general, lenders prefer your mortgage cost no more than 28 percent of your gross monthly income, and that your mortgage and other debt payments total no more than 36 percent of your monthly income. For a conventional loan, lenders may approve DTI ratios of up to 45 percent. This is more likely if you have significant savings or a strong financial profile otherwise. 

If you make $5,000 per month, you’ll want a mortgage payment of no more than $1,400 ($5,000 x 0.28). Your mortgage and other debt payments should ideally remain below $1,800 ($5,000 x 0.36). You can improve your DTI by increasing your income or paying off debt.

5. Check out different mortgage loan types and terms

If you think you’ve found your long-term home and have good cash flow, consider a 15-year fixed-rate mortgage instead of the traditional 30-year fixed-rate mortgage. You’ll pay more each month, but you’ll pay off your home sooner. Plus, you’ll pay less in interest since interest rates on 15-year mortgages tend to be lower than those of other mortgage options. You can also choose a 15-year term if you’re refinancing your current mortgage.

Alternatively, while rates are high, you might consider an adjustable-rate mortgage (ARM). With these types of loans, you’ll start with a fixed rate for a set time — often five or seven years — which is typically lower than what you’d get with a fixed-rate mortgage. After this period ends, your interest rate can increase or decrease for the remainder of the term. When that happens, or whenever rates fall, you could refinance an ARM loan into a fixed-rate mortgage.

Finally, government-backed loans may offer lower rates than conventional loans. Your options include:

• FHA loans: Insured by the Federal Housing Administration, FHA loans are popular with first-time homebuyers because of their flexible financial requirements.
• VA loans: If you or your spouse have served in the military, you could consider a VA loan, which is guaranteed by the U.S. Department of Veterans Affairs. These loans typically have no down payment requirement.
• USDA loans: Guaranteed by the U.S. Department of Agriculture, the USDA loan program is designed to help low- and moderate-income people in rural areas buy a home. There’s no down payment needed, but your home must be in an eligible area, and your income cannot exceed a certain amount, based on your location and household size.

6. Consider paying mortgage points

If you’re willing to pay a fee, you can buy your way to a lower interest rate using mortgage points. Each point costs 1 percent of your mortgage amount and typically reduces your interest rate by 0.25 percent. You can think of mortgage points as a form of prepaid interest.

Let’s say that you have a $400,000 home loan with a 7 percent interest rate. If you want a lower rate, you could buy a mortgage point for $4,000 and knock your rate down to 6.75 percent.

However, buying mortgage points isn’t right for everyone. Recouping the upfront costs typically takes around five years, so this strategy isn’t ideal if you plan on selling within a few years.

7. Compare offers from multiple mortgage lenders

When you’re looking for a mortgage, even for a refinance, don’t accept the first rate you’re quoted. Shop around with at least three lenders, including your own bank or credit union and at least one online option. 

“Shop and compare based on the loan estimates received,” Saunders says. “You wouldn’t normally purchase a car without test-driving it first. Test drive your loan before proceeding with your purchase.”

Even if the interest rates are comparable, lenders’ offers come with different fees, closing costs, private mortgage insurance premiums and more. By shopping around, you can choose the offer with the most favorable terms.

8. Lock in your mortgage rate

Sometimes the closing process takes several weeks, during which rates can fluctuate. After you sign the home purchase agreement, ask your lender to lock your rate. The service sometimes comes with a fee, but it often pays for itself, especially in volatile rate environments. Source