If you are like the majority of people interested in purchasing a home, you probably have questions about how to obtain the lowest possible interest rate. Your interest rate can have a significant impact on the amount you pay for your home, so it’s worth doing some research ahead of time to learn how to keep it as low as possible.
Unfortunately, the process by which your interest rate is determined can be complicated and isn’t always transparent. However, there are some major factors that will definitely affect your rate. This isn’t an exhaustive list, but it’s a good starting point:
1. Home Location
Some lenders price their loans differently by state and even by neighborhood. State laws determine the foreclosure process and may affect their ability to collect if you default. In addition, homes in some areas are worth more and homes in up-and-coming areas may be considered less risky by your lender. by the same token, homes in rural areas or low-income areas may be riskier. In fact, some lenders won’t offer loans in those areas at all.
Talk to your real estate agent and loan officer to see if there are any details you should know before you start house-hunting in a particular location. You’ll need to balance the area you want and can afford to live in against the likely impact on your interest rate.
2. Credit Score
Your credit score is one of the most important factors used to determine your interest rate. It helps to predict how reliable you will be in paying off a loan. Your credit score is ultimately calculated after an analysis of your credit report which shows all credit cards, payment history, and loans attached to your name.
With a higher credit score, you will be able to get a lower interest rate. Before you begin your mortgage shopping process, get your credit report so that you can see what your score is and identify and fix any errors. Look for areas that may be impacting your score, such as past-due accounts, and work to get those areas back on track.
Bear in mind that changing your credit score quickly is challenging. It’s better to take a long-term approach to it and implement strategies to improve your credit rating months in advance or even longer. Waiting a few months while your score improves can save you thousands or even tens of thousands of dollars on your home down the road.
3. Loan Amount and Home Price
The total cost of the home minus the down payment is the amount that you will need to borrow for the mortgage loan. You’ll pay a higher interest rate if you’re taking out a very large or very small loan.
When you start shopping for a home, you may be approved for a mortgage higher than what you need. You certainly do not have to take the maximum, particularly if you find your dream home in a more-affordable bracket. Talk to your loan officer about your budget and the amount you plan to borrow and shop around for a lender that will give you the best deal.
4. Down Payment
If you put down a higher down payment, your interest rate will typically be lower. That’s because lenders see you as a lower risk when you have a higher stake in the property. Putting down 20% or more will give you the best results as far as your rate goes. Just like improving your credit score, it may well be worthwhile to wait a little longer before purchasing a home if it means you can make a 20% down payment.
Note that not all lenders will require a down payment of 20%; some programs allow you to put down just a few percent. However, your rate will be much higher.
5. Interest Rate Type
Interest rates may be adjustable or fixed. A fixed interest rate won’t change over time – you agree to it up front and it stays the same over the course of your loan. An adjustable rate will typically be fixed for an initial period and then increase or decrease based on the market. With an adjustable rate loan, you’ll usually be able to get a lower initial interest rate. However, that rate could increase significantly down the road if the market moves up. If you have an adjustable rate loan and the market drops, you may want to consider refinancing and switching to a fixed-rate loan to lock in that lower rate.
6. Term of the Loan
Shorter-term loans typically will have lower interest rates and lower costs over all but lead to higher monthly payments. Many home loans have 30-year terms, but you may be able to get a term as low as 15 years. You’ll need to balance the loan term against your budget and what your lender is willing to offer.
7. Type Of Loan
There are several different categories of mortgage loans, including VA loans, FHA loans, and conventional loans. The rates of each type of loan can vary significantly. Some are subsidized by the federal government to ensure access to loans and support home ownership among certain populations. If you qualify for these loans, be sure to compare them to traditional loans to make sure you’re getting the best deal possible.
The Bottom Line
There are a lot of mortgage loan options out there and many factors that can affect your interest rate. Before you start seriously shopping for a home, take a comprehensive look at your finances and the neighborhoods you’re considering to get a sense of what kind of interest rate you can expect to pay. The rate you’re offered may vary a lot by lender, too, so make sure to shop around and see what different lenders can offer.
Happy house hunting!