A 2017 Experian survey found that younger people (millennials, broadly defined) are opting out of homeownership at alarming rates. More than one-third of respondents aged 18 to 34 indicated they’d opt out of homeownership for the time being.
The most pressing concern, according to survey respondents, is the cost of owning a home. Some 54% of all survey respondents said homes were too expensive at the moment, while 30% were wary of the debt loads associated with homeownership.
But other concerns weigh too. Some 43% of survey respondents indicated that they’d been turned down for a home loan at some point in the past, with more than half citing poor or insufficient credit as the likely culprit. More than half – 56% and 54%, respectively – said they were actively working to improve their credit or delaying the purchase to hold out for a better interest rate.
Why Your Mortgage Interest Rate Matters
The prospective buyers holding out for better interest rates are onto something. Even small interest rate changes can dramatically change the financial calculus of homeownership.
Don’t believe me? Play around with this Bankrate mortgage refinancing calculator. Here’s a simplified scenario:
- Current Monthly Payment: $1,000
- Amount Left on Mortgage: $200,000
- Time Left on Mortgage: 29 years
- Current Rate: 4.5% APR
- New Rate: 3.5% APR
- New Monthly Payment: $915.66
- Monthly Savings: $84.34
- Total Interest Savings: $29,349.59
A seemingly small interest rate reduction, from 4.5% APR to 3.5% APR, was enough to reduce this $200,000 mortgage’s lifetime interest burden by nearly $30,000 and trim the hypothetical borrower’s monthly payment by about $84.
Now, imagine what you could save with a comparable interest rate reduction on a larger loan, or a larger rate reduction on a comparably sized loan. That’s the power of a prime credit score – and a powerful argument in favor of waiting to buy until your credit house is in order.
Tips to Get Approved for a Mortgage & Qualify for a Lower Rate
In the rest of this post, I outline some straightforward tips for prospective homebuyers looking to do two things:
- Get approved for a mortgage loan
- Lower their effective interest rate or total payment over the life of the loan
The two aren’t mutually exclusive. Some of the same tips that you can use to get your loan application approved may help lower your interest rate. Still, if there’s a distinction to be made, I’ll make clear to which priority each tip applies.
First things first: putting your best foot forward.
Improve Your Financial Profile
Loan officers are a nice enough bunch, but they’re not your friends. They don’t really know you. Their interests lie with their employers – lenders – and only indirectly coincide with your family’s.
To qualify for a mortgage, it really helps to have a W-2 job. It’s not impossible to qualify for a mortgage as a freelancer or sole proprietor, but you’ll have to jump through more hoops. If you’re a freelancer, your lender is most likely going to want to see your past two years of income in order to calculate your monthly earnings.
Volatile earnings can complicate your financial picture, making you look riskier on paper than you really are. Couples who’ve merged their finances and have at least one full-time W-2 employee are better positioned than single freelancers without regular sources of supplemental income. The more stable your employment history, the better.
In either case, you’ll need to gather ample financial documentation showing all significant sources of income, going as far back as required by your lender: pay stubs, 1099s, brokerage and bank account statements, public assistance, and records of any other income you’d report to the IRS.
As a general rule, you’ll want to err on the side of comprehensiveness. Include at least one month of pay stubs, two years of salary verification records (including bonus and commission income), your past two tax returns, profit/loss statements (if you own a business), two months of bank and brokerage account statements, and two months of retirement account statements (if applicable).
Get Cozy With Your Credit
Obtain at least one credit report before beginning the application process. You’re entitled to one free credit report per year from each of the three major consumer credit reporting bureaus: Experian, Equifax, and TransUnion. Check the FTC’s website or visit AnnualCreditReport.com for more details.
Once you have your credit report, study it closely. Look for mistakes and omissions that might negatively impact your credit, such as loans for which you didn’t apply (a potential sign of identity theft) or delinquencies reported in error. Get familiar with your negatives too: judgments, liens, past bankruptcies, reported delinquencies, and so on. Chances are good you’ll be aware of most, but there’s always a chance you’ll find a legitimate black mark that hadn’t crossed your radar screen.
Before and during the application and underwriting processes, avoid making any financial moves that could upend your credit. Those include applying for new loans or lines of credit (including credit cards) or making big purchases on credit, which could affect your debt-to-income ratio (more on that below).
Reduce Your Debt-to-Income Ratio
Your debt-to-income ratio is a major component of your credit score – and a major factor in determining your mortgage loan qualification and rate.
Reducing your debt-to-income ratio isn’t a one-day process, of course. Kick it off as early as possible, even before you’re ready to start actively searching for your next home. Over time, this can increase your credit score, making you more attractive to prospective lenders.
Lenders take debt-to-income ratio into direct account too. Smaller lenders generally cut prospective borrowers off at 43% debt to income, including the Consumer Financial Protection Bureau. Larger lenders may accept higher debt-to-income ratios – at the cost of a higher interest rate. To get your debts under control, concentrate on paying off your largest debts first, then circle back to the smaller stuff.
Take a Homebuyers’ Course
Not totally confident in your ability to navigate the treacherous waters of the housing market? Try a homebuyers’ course.
Many municipal governments, neighborhood councils, and nonprofit organizations offer courses for first-time and returning homebuyers. If you can’t find any that align with your schedule or take place close enough to attend in person, look for online courses or hybrids. The city-sponsored course I attended in Minneapolis was basically an overview of a much more extensive collection of educational resources available online. All told, it took about three hours of my time: 90 minutes one evening and another 90 minutes at home.
Homebuyers’ courses aren’t guaranteed to reduce your homeownership costs, cautions Ross, but they can certainly increase your confidence during the buying process and help ease the financial burden. And most comprehensive courses do include tips to reduce your interest rates and monthly payments. Paying attention could pay off.
Source Multiple Quotes
Before you dive into the home buying process, use at least one online aggregator to source mortgage loan quotes from multiple lenders.
Google “get a mortgage quote” and you’ll see just how many aggregators – not to mention lenders – are out there. I’m a fan of Realtor.com, but it doesn’t matter which one you use. Remember, you’re under no obligation to take any action on your quote. This step is for informational purposes only, and the quotes themselves are nonbinding. Only after you decide to move forward and begin the underwriting process with a particular lender will you receive an official proposal.
Getting a preliminary quote is pretty straightforward. You’ll need to answer basic questions about:
- Your location
- The intended use of the home you’re buying (primary residence, second home, and so on)
- The type of house (single-family home, duplex, condominium)
- Your income (and ability to provide proof of income)
- Your previous homebuying experience
- Your desired loan structure (fixed- or adjustable-rate)
- Your desired loan term (most commonly 15 or 30 years)
- Your price range
- Your credit profile
In some cases, you’ll get a preliminary quote almost immediately. In others, you’ll need to provide your contact information and wait for the lender to follow up. Repeat as needed, and you’ll soon have a pretty good sense of the rate range into which you’ll fall. It’s straightforward from there: Choose from among loans with the lowest rates – or, if cash flow is an issue, structures most conducive to lower monthly payments.
Use Multiple Brokers
Sourcing multiple preliminary quotes is easy. Getting into the weeds with multiple brokers is more complicated and time-consuming. No surprise, then, that many homebuyers don’t do it. But it’s a great strategy – and likely to pay off financially, because you’re essentially playing two (or more) commission-hungry brokers off one another.
Do Your Own Rate Negotiations
You don’t need a broker to negotiate on your behalf, particularly at the lower end of the housing market.
If you’re willing to do the legwork on your own, approach lenders offering the best rates and terms (sourced through Realtor.com or another aggregator) and see if they’re willing to budge. Be transparent about their competitors’ offers. If they really want your business, they’ll negotiate – especially in slower markets, when they could really use the business.
Consider a Shorter Loan Term
A shorter loan term can dramatically reduce your long-term homeownership costs. The downside: Shorter-term loans invariably demand higher monthly payments. Switching from a 30-year to a 15-year mortgage can reduce your headline interest rate by about 0.5%, saving thousands over the life of the loan.
Needless to say, that’s fantastic news for your long-term financial health. Every dollar you don’t pay in interest is a dollar you can save for retirement or plow back into your home via equity-enhancing home improvement projects.
Look at FHA Loans
If you have limited savings and modest income, you could take years to save for your down payment. Buyers in your shoes often choose FHA loans, which allow smaller down payments – as low as 3.5%. FHA loans also have looser underwriting standards than conventional loans. That’s good news if your credit isn’t where you’d like it to be, but you aren’t keen on waiting months or years to reach prime borrower status.
Most importantly, FHA loans can have lower interest rates than conventional loans, though your rate will depend on your credit score and other factors specific to your situation.
On the other hand, FHA loans command hefty mortgage insurance premiums in two phases: upfront and ongoing for the life of the loan. By contrast, conventional loans’ mortgage insurance premiums automatically terminate at 78% LTV. All else being equal, this ongoing burden could raise your FHA loan’s monthly payments above the projected monthly payments on a corresponding conventional loan, damaging the FHA loan’s rationale. Before you settle on an FHA loan, crunch the numbers – or ask your lender for guidance.
Increase Your Down Payment
When it comes to down payments, bigger is usually better – at least, for buyers focused on scoring the lowest possible interest rate.
That’s not just because you’ll necessarily have to borrow more to compensate for your smaller down payment. For lenders, down payment size is inversely correlated with default risk: bigger down payments mean lower risk. Lenders offset this risk with higher interest rates (and mortgage insurance). Increasing your down payment from 10% to 20% could reduce your rate by 1% to 2%, likely saving tens of thousands in interest over the life of your loan.
When money is tight, increasing your down payment is easier said than done. Government- and nonprofit-run down payment assistance programs can help – if you qualify. There’s almost certainly a program operating in your area. A quick Google search can confirm.
Many down payment assistance programs offer grants that don’t need to be repaid. In other words, they won’t increase your interest rate or your total homeownership costs. Others offer no-interest loans, which increase homeownership costs but not your interest burden. Check with your state and municipal housing authorities first, then look to local housing nonprofits.
Most down payment assistance programs are means-tested, meaning you won’t qualify if your income is too high. Others are restricted to specific buyer groups, such as veterans and first-time homebuyers.
Even if you can technically afford a higher down payment, you’d do well to look into these programs. It’s simply not wise to fork over every last liquid cent at closing. You need something left over for your emergency fund and short-term personal savings.
Pay for Discount Points
Paying for mortgage discount points is known as “buying down the rate.” It’s a fantastic strategy for buyers with ample cash cushions.
Discount points are fees due to your lender at closing. They’re called “points” because each corresponds to 1% – one percentage point – of the total loan value. On a $200,000 mortgage, one discount point costs $2,000.
Rather than contribute this cash to your down payment, you can use it to reduce your interest rate. Depending on your loan’s rate, term, and size, paying for points can reduce its long-term costs far more than a corresponding increase in your down payment.
Generally, each point reduces the loan’s interest rate by 0.25%, but this amount may vary by lender. It’s usually possible to pay for half and quarter points, which reduce your rate by 0.125% and 0.0625%, respectively.
Paying for points only makes sense for buyers who plan to remain in their homes for several years. Before opting to pay for points, you’ll need to calculate your breakeven point by dividing your total point cost by your projected monthly payment savings. That calculation’s quotient represents the number of months you’ll need to stay in the home to recoup your point costs via saved interest. Expect the breakeven period to be at least five years in the future.
Even a small negative change to your mortgage loan rate can substantially improve your financial picture for the better. It’s well worth your while to follow the tips outlined here and pursue a lower rate, as long as you don’t have to make other compromises that may raise your long-term homeownership costs.
But it’s also important not to view the mortgage loan application process in a vacuum. Buying a home is a marathon, not a sprint. You’ll need to worry about much more than just your top-line mortgage rate: ordering a thorough home inspection, securing title insurance, calculating your closing costs, and more.
When homebuyers fail to fully account for all these upfront and ongoing costs, they’re more likely to run into trouble down the line, so make sure your home buying appetite isn’t bigger than your wallet. If and when your resources and borrowing capacity allows, you can always upsize.
Are you applying for a mortgage? What are you doing to ensure your application goes through and you get the lowest possible rate?