The Wall Street Journal had a report this weekend on how to snag the best mortgage rates. While some of the tips you’ve probably heard before, I thought it was still worth sharing. With rates at historic lows and real estate prices ready to rebound, it seemed like a good time to review the basics.
What Determines Your Mortgage Rate?
There are seven factors that will determine the interest rate you get on a mortgage:
- The FICO credit score of each borrower
- Home price and the amount of the mortgage
- Property location
- The amount of your down payment
- Loan term (e.g., 15 year vs. 30 year)
- Type of interest rate (e.g., fixed vs. variable)
- Loan type
(Source: CFPB). To this I’d add one more factor–your lender.
Let’s take a look at each of these factors, and what it takes to qualify for the best mortgage rates.
1. FICO Credit Score
Improving your credit score is the single best way to save money on everything, from home loans to car loans and even car insurance. With a mortgage, a good credit score can easily save you tens of thousands of dollars over the life of the loan. The best mortgage rates go to those with a FICO score of 760 or better.
Improving your score is a matter of paying bills on time and keeping the amount of credit you’re using to a minimum. That’s sometimes easier said than done, but over time your score should improve. You can check out a list of tips to increase your credit score for more details.
If you don’t know your FICO score, there are several ways to get it. First, you can buy access to your score directly from myFICO. It’s not expensive and you get your FICO score from all three credit bureaus.
If you don’t want to pay for your score, many credit card issuers offer free access as well. You’ll find a list of credit cards that offer credit score access here.
Finally, you can get free access to credit scores through Credit Karma. The score is not based on the FICO formula, but it does a good job of replicating the FICO score. It also provides great information on ways to improve your score. And as I mentioned, it’s free.
2. Home Price and Mortgage Amount
The cost of the home and amount financed also affect mortgage rates. Here, mortgage loans fall primarily into one of three categories (Source: FreddieMac):
- Conforming: These are loans of $417,000 or less;
- Super Conforming: For those that live in certain expensive areas of the country, mortgage loans can go up to $625,500 for a single unit and still qualify as super-conforming; and
- Jumbo: Mortgages that exceed the limits of Conforming and Super Conforming.
The key here is that, all other things being equal, a conforming loan will have a lower rate than a super conforming, which in turn will have a lower rate than a jumbo mortgage.
Using our mortgage rate tool, I found that the difference between a conforming mortgage and a jumbo was nearly 50 basis points.
3. Property Location
As noted above, expensive areas of the country will qualify for super conforming mortgages. In those cases, the rates will be lower than if the mortgages were jumbo loans.
4. Down Payment
While the WSJ didn’t mention this one, I think it’s an important consideration. You’ll typically get the lowest rates if you have at least a 20% equity cushion. Anything less than this? Your rates go up and you’ll pay private mortgage insurance (PMI). We paid PMI on our first home, and the extra cost just goes right out the door. Saving a 20% down payment isn’t easy, but it will save you a lot of money in the long run.
5. Loan Terms
The WSJ article suggested that you can opt for a 25-year mortgage as a way to get a lower rate. I actually tried that with my last refi, but the rate wasn’t any lower. In fact, the rate was the same even for a 20-year mortgage, as compared to the 30-year loan we ultimately chose.
You do, however, save on interest when you go down to a 15-year mortgage. The downside, of course, is a much higher payment. There are other factors to consider when deciding on a 15 vs. 30-year mortgage, but it is worth considering as one way to lower your rate.
6. Fixed vs. Variable Rate Mortgages
Whether the interest rate is fixed or variable affects the rate. All other things being equal, a variable rate mortgage will start with a lower rate than a fixed rate mortgage.
7. Type of Mortgage
There are many different types of mortgage products. In addition to commercially available mortgage products, there are HFA loans and VA loans. Each of these mortgage products come with unique terms and requirements. The mortgage rate also varies from one product to the next.
Get Several Quotes
This one is simple. It’s easy to compare mortgage rates online. In addition, if you are refinancing, it’s always worth checking with your current bank to see what they can offer. It pays to get at least three quotes, if not more.