With interest rates remaining at historic lows, you may decide that now is the right time to start searching for your new home. And that makes sense: the lower your interest rate on your mortgage, the more money you’ll save over the life of your loan. Just a one-point difference can mean saving thousands of dollars over 15 or 30 years. So you may be shocked if you prequalify for a mortgage and find that your quoted rate is much higher than what the lender advertised as possible. The reality is that the lowest advertised interest rate may not be anywhere close to the rate for which you can qualify based on your financial fitness and lending market conditions. Consider the following reasons, then find out how to score the best interest rate possible.
1. Your credit score is less than excellent
Unless your credit score is near perfect (above 800), a low (580-650) score will be the biggest reason you aren’t offered the lowest advertised interest rate. While those great low rates are available, lenders usually don’t quote them to borrowers with credit scores below the 800s. However, you can control and influence your credit score in the near term and long-term by understanding how your credit score is calculated. There are also services that can help clean up errors on your credit report to accelerate improving your score sooner than later. However, the best way to maintain a strong credit score is to understand how it’s calculated, review your estimated credit score for free on an annual basis, and make sure you pay your debt on-time.
2. High Debt-to-Income Ratio
Another key area to your financial fitness and ability to obtain the lowest mortgage rate possible, is your debt-to-income ratio. This is an important ratio to understand when purchasing a home as it’s a key measure for mortgage companies to assess their risk to loan you money. To qualify for a conventional mortgage, your Debt-to-Income should be less than 45%. For a first time homebuyer, there are programs out there that you can qualify for with up to 55% Debt-to-Income ratio. For example, if your after taxes take-home pay is $5,000/month, all of your monthly debt payments should not exceed $2,250. Your monthly debt payments would include mortgage + car loans + student loans + credit cards + personal loans = $2250 or less. As you can see, the less consumer debt you have (credit cards, car payments, student loans, etc), the more buying power you have for your home purchase. However, in my opinion, it’s never $mart to be ‘House Poor’. Even if you can qualify for a loan up to 45-55% of your monthly net income, this usually puts too much financial pressure and stress on homeowners. When we work with clients to purchase a home, my general rule of thumb is to keep your debt-to-income ratio below 35%. This allows you to continue to follow our 20/30/50 budgeting guideline to financial fitness while giving you the flexibility to still enjoy other things in life, such as vacations, eating out, home improvements, etc.
3. Your lender doesn’t want to get competitive
Did you receive a quote for an interest rate from a mortgage broker or bank and get a surprise when the numbers came back much higher than you expected? Remember that lenders make profits from the interest they charge on money they lend to you. If, for whatever reason, an institution or lender doesn’t feel the need to offer competitive rates, your quote may come back with a much higher number than you believe you deserve, even if you have a solid credit score and acceptable debt-to-income ratio. Lots of external factors influence a lender’s decision, such as the economy, current marketplace, and the amount of competition in the home loan space. This area is generally out of your control, but important for you to be aware of when shopping for a mortgage. That’s why we always recommend getting at least 2 or 3 mortgage quotes from different lenders.
Focus on what you can control to get the best interest rate
Knowing why you didn’t get the best interest rate advertised doesn’t make it any less frustrating when the rate you see is much higher than you expected. While some factors are outside your control, focus on what you can influence, like your credit score and the amount of debt you carry. You can work to boost your score before you apply for a mortgage. Be sure to consistently make payments on credit card balances and bills in full and on time. Don’t open new lines of credit right before you apply for a mortgage, and don’t go crazy closing old accounts either as this can send red flags to the credit agencies. Finally, repaying current debts before taking on more debt to purchase a home is a savvy financial decision that will benefit you — both when you apply for a loan and after you get it (when you’ll need to manage that new monthly mortgage payment). If you currently carry debt, establish a repayment plan you can stick with and work aggressively to pay down your balances. Building your credit and repaying your debt can take time — and that’s OK. You may need to push out your timeline for applying for a mortgage and buying a house a little more, but it’s well worth doing to get the absolute best interest rate for which you can qualify.