Getting a great rate on a mortgage is about a lot more than comparison shopping. It’s also about much more than just your credit score. In fact, the mortgage industry examines a number of factors to determine not only if you qualify for a mortgage, but also what interest rate you’ll pay.
There’s a lot at stake. Mortgage rates can vary by several percentage points depending on the factors we’ll look at below. The difference can mean a much higher or lower monthly payment and tens of thousands of dollars in interest payments over the life of the loan.
If you hope to get the best mortgage rates possible, you’ll need to make sure that you are well-qualified. Below are some of the key criteria that mortgage lenders evaluate, as well as some tips you can use to improve your current standing.
Mortgage lending today is based on tiered pricing, which means that rates are adjusted based on various criteria. One of the main criteria used is your FICO credit score. Your credit score will help to determine whether you qualify for the loan and what rate you’ll pay on your loan, and there is an inverse relationship. The higher your credit score, the lower your mortgage rate, all other things being equal.
According to myFICO.com, the best mortgage rates are available to borrowers who have credit scores of 760 or above. As your score goes lower, your interest rate goes up. With some exceptions noted below, the lowest score needed to qualify for a mortgage is 620. At today’s mortgage rates, however, a score of 620 will qualify for a rate of 5.022%, while those with a score of 760 or higher will enjoy a lower rate of about 3.433%.
You can, in theory, qualify for a mortgage with a credit score as low as 500. It will require a minimum down payment of at least 10%. In order to get maximum financing on an FHA loan (a 3.5% down payment) you need a minimum credit score of 580.
If you don’t meet the minimum credit score requirements, or if you want to improve your chances of getting the best rates, you’ll need to begin monitoring your credit scores (you’ll find several free options here) and making improvements where necessary. This can include paying down or paying off loans, paying past-due collection accounts, and cleaning up any errors you discover on your credit report.
Employment and Income Stability
Mortgage lenders prefer candidates that can prove steady employment for at least the past two years. Long periods of unemployment won’t bode well for your application, and neither will a pattern of declining earnings. In a perfect world, you have been on the same job for at least the last two years, or have made a job change to a higher paying position in that time.
Lenders tend to be especially strict when it comes to self-employment income. According to Bankrate, they will require that you document your business income with income tax returns for the past two years. And they will generally have you execute IRS Form 4506, which will enable them to obtain a transcript of your returns in order to verify they are the same ones you sent to the IRS.
Debt-to-income ratio – also called DTI – comes in two forms. The back-end ratio measures the total of all of your monthly minimum debt payments, plus your proposed new housing payment, divided by your stable monthly gross income. The front-end ratio focuses just on your housing costs, excluding all other debts. Historically, banks have wanted to see a front-end ratio of no more than 28% and a back-end ratio of no more than 36%. Depending on the type of mortgage and other factors, however, these ratios can go higher.
For example, the maximum back-end DTI is 43% for an FHA loan. There may be some flexibility, however, if you meet certain criteria. For example, the mortgage lender may allow you to exceed the limit if you are strong in every other area of your loan application. Further, a lower DTI may result in a lower interest rate.
As a general rule, you’ll need a minimum down payment of 20% of the purchase price of your home in order to get the best mortgage rates. Since mortgages are price adjusted based on risk factors, a loan with 5% down is considered higher risk than one with 20% down, and will carry a higher interest rate.
But that isn’t the only reason to save up 20%. When your down payment is less than 20% of the purchase price, you will likely have to pay PMI, or private mortgage insurance.
On a conventional loan with a 5% down payment, mortgage insurance will effectively add .62% to your payment (assuming a credit score of between 720 and 759). On a $200,000 mortgage, this will translate into an annual premium of $1,240, adding an additional $103.33 to your monthly house payment.
In the mortgage world, cash reserves are measured in terms of the number of months worth of house payments you have saved in cash. The reserve includes money saved in checking or savings accounts, money market funds, or certificates of deposit. However, it generally does not include funds in a retirement plan since that money can only be withdrawn after paying taxes and penalties.
The standard requirement for cash reserves on a mortgage is two months – as in you must have enough liquid cash after closing to cover your new mortgage payment (principal, interest, taxes, and insurance) for at least the next 60 days. On higher risk mortgages, the cash reserve requirement may be higher.
Finding the Best Mortgage Rates
Once you’ve positioned yourself for the best mortgage rate, it’s time to comparison shop. Fortunately, it’s very easy to do. The last time my wife and I refinanced our home, we found a great rate on mortgage tables I maintain on my own blog. There are, of course, other options.
Bankrate.com: Bankrate.com is one of the best established mortgage rates sources on the web. Bankrate’s Compare Mortgages page is an excellent place to start, especially if you’re looking for a way to compare the most attractive rates among different lenders. After you enter some general information in the tool, it provides a list of mortgage lenders with the best rates for the specific type of loan you need.
Zillow.com: One of the most widely visited sites in the real estate industry,Zillow.com also provides information on mortgage lenders. To use the site, you’ll have to go through a series of screens and input certain information, including your contact information. Once you have completed the input, lenders will contact you with rate quotes.
Check with your Bank or Credit Union: You should also check with your bank or credit union. They often have preferred rates for customers that may be lower than what is available to the general public. And since you’re a member, you’ll have a much better chance to get approved for the lowest rate possible. Some banks even offer discounted rates for banking customers who sign up for auto-pay or meet other criteria. For example Webster Bank of New England offers a 0.125% rate discount if you pay your mortgage using ACH debits from your checking account.
Applying for a mortgage is a complicated process, but it becomes a whole lot easier when you have your ducks in a row before you get started. So take some steps to improve your credit, pay down some debt, and start saving. Getting the best mortgage rates isn’t just about shopping around. It’s about getting your credit and finances in the best shape possible.
Original Article by Rob Berger via Forbes
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