If you’re buying a house, you want to get into the lowest mortgage rate possible. After all, mortgages are a commodity. You don’t get extra special benefits for paying more every month.
Let’s take a look at how each of these factors can affect the rate you get. After that, we’ll go over some strategies that can help you qualify for a low rate.
Factors Affecting Your Mortgage Rate
What’s IPAC? It sounds like a knockoff iPad on a late-night infomercial – “Call right now and we’ll double the offer!” Don’t worry, you can put the credit cards away.
IPAC is a convenient acronym to remember the factors that go into your mortgage interest rate: income, property, assets and credit.
The type of interest rate you can get – whether it’s for a car, a house or any other type of loan – is dependent upon the level of risk the lender is taking on that loan.
With that in mind, the income portion of this is easy. Higher incomes likely mean you’ll have more resources available. This doesn’t mean you have to be a millionaire to purchase a $250,000 house, but the lender wants to see that you can comfortably make your monthly payment. This is determined by looking at your debt-to-income (DTI) ratio. We’ll get deeper into this in the credit section below, but for right now, know that higher incomes mean more money to pay off debts including your mortgage.
The property portion of IPAC comes down to the type of property you’re buying. A lot of this depends on whether it’s your primary home, a second home or an investment property.
Again, interest rates are all about risk. When you buy a house, you know what you can afford and plan to make the payments. If you fall on hard times, however, you’re likely to pay off certain things before others.
Interest rates are higher for second homes and investment properties, because if something were to go wrong, you’d likely make the payment on your primary property first.
Interest rates are also different based on whether it’s a single family property or a multi-unit complex like condos.
Higher assets are another thing that can work in your favor in terms of a mortgage. Assets are things not related to your annual income that could be used to help pay off your mortgage. This could be proceeds from the sale of property, stocks, bonds, mutual funds, etc.
Obviously, the more assets you have, the greater your ability to repay and the lower your interest rate will be.
All lenders look at your credit score and history. In general, the higher your credit score, the lower your rate. You keep your credit score up by making timely payments for your house, car, credit card and so on.
Your credit report is also used to determine how much of your monthly income goes toward making debt payments. Let’s say you make $5,000 a month and you pay 1,250 of that toward your student loans, house and car payments. Your DTI is 25%. The lower this ratio is, the less risky you are for the lender. Your rate will be lower.
For more on this topic, check out this post on how you credit score affects your mortgage eligibility.
Getting a Low Rate
Now that we’ve gone over the factors that go into your mortgage rate, how do you go about securing a low one? There are a few strategies you can employ.
Pay Off Debt
While you don’t want to close every account, it can be helpful to pay off certain debts. Taking this action will decrease your DTI and free up more money for you to spend on your monthly mortgage payment. Less debt can mean a lower rate.
Prepaid interest points
You can buy your rate down by pre-paying interest at closing. This prepaid interest is called a mortgage point. One point is equal to 1% of the loan amount (i.e. on a loan amount of $100,000, one point is $1,000). You can purchase points in increments down to 0.125 points. Many of the interest rates you see advertised have a certain number of points attached to them.
Prepaying this interest will get you a lower rate. The trade-off here is that you have to stay in the home long enough to reach a break-even point where you save money. If buying two points on a $250,000 mortgage (two points equals $5,000) saved you $300 per month on your mortgage payment, you’d have to stay in the home 17 months to break even. If you plan on staying in the house for a while, though, it’s a good way to save money.
Higher Down Payment
A higher down payment at closing will get you a lower rate. A significant down payment amount lowers the amount the lender has to give you in order to complete the purchase. The lower your loan-to-value (LTV) ratio, the more you’re considered a good investment.
It’s important to note that the interest rates you hear about in the media often represent baseline rates and don’t necessarily reflect the exact rates clients get. When you receive a quote for a rate, it’s unique to your personal situation.
For more info on baseline rates, check out this post on how mortgage rates are influenced by the bond market.
Now that you know what goes into your interest rate and how to bring it down, you can go put that knowledge to good use. If you have any questions, let us know in the comments.
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