This holiday season, all you would-be home buyers should give yourselves the best gift possible: the lowest mortgage rate you can get! It may not come in a little blue box, but it will truly be the gift that keeps on giving.
The reason: Your mortgage rate determines how much you have to pay for your home each month, which in turn determines how much you can qualify to borrow. The loan amount plus your down payment determine the price of the home you can afford.
It’s really a numbers game, and you know what else is a numbers game? Baseball. In the nonfiction book “Moneyball,” later made into a movie starring Brad Pitt and Jonah Hill, author Michael Lewis chronicled the rise of the Oakland Athletics under a new, data-based approach to recruiting players and playing the game. The bottom line? The best offensive players are the ones who get on base the most, not (necessarily) those with the highest batting average or home run count.
So like the team managers in “Moneyball,” you want to learn to pay attention to the numbers that matter. Take the interest rate, for example. You may read news reports about what the 30-year fixed-rate was this week, but the truth is, like gas prices, mortgage rates vary dramatically by lender, loan type, location, consumer profile, and even property.
As a housing economist, I have the opportunity to observe what rates people are getting on mortgages and how they vary. I’ve been able to determine seven key data-driven tactics to help you buyers to get on base—and all the way home.
1. Work to achieve and maintain a FICO of 750 or higher
This tactic requires getting your financial house in order, so it is likely the hardest piece of advice to follow. The rate you will receive on a mortgage is a function of your credit score (and the credit score of any co-borrowers). To receive the best rates, you need a 750 FICO credit score. Achieving such a score is not impossible—more than one-third of people in the U.S. have a 750 or higher FICO. So find out how the credit bureaus currently score you. Then research how to improve the score.
2. Allow for a debt-to-income ratio of no more than 35%
The debt-to-income ratio is one of the most critical metrics in determining your rate and whether you qualify. Like with your credit score, having a lower DTI will require you to be better than average—the average DTI on purchase mortgages this year is 36%.
It’s usually not that easy to change your income, so focus on the two things you canchange: your purchase price and your debts. Budget your purchase price so that your DTI is 35% or less. If you can, pay off debts such as student loans, revolving credit card debt, or car loans and leases. Don’t incur any new debt.
You can qualify for a mortgage with a higher DTI than 35%, but above that level you will typically pay a higher rate.
3. Put at least 10% down
The amount of money you put down determines how much equity you have in your home from the onset of your mortgage. Buyers with 20% or more equity have much lower default rates than buyers with less, so lenders are very sensitive to how much you put down.
Putting 20% down will provide for the lowest rate and also allow you to avoid the additional cost of mortgage insurance.
However, for many buyers, especially first-timers, putting 20% down is a tall, if not impossible, order. I purchased my first home with only 10% down, and that’s the level of down payment that will often get you the best rate, with all other factors being equal.
4. Look at options beyond a 30-year, fixed-term mortgage
The 30-year fixed loan term is by far the most popular in the U.S., but that doesn’t mean it is the best option for every buyer. When you spread payments out over 30 years, the monthly bill is lower than when it’s spread over 20 or 15 years. But shorter terms will in most cases result in lower rates.
A fixed rate gives you the most protection from having to make higher payments in future years if rates go higher. We know that rates will likely be higher in future years, so this seems like a good option. However, 30 years is much longer than most buyers expect to live in a home. A hybrid-loan term, which fixes the rate for a shorter duration such as five, seven, or 10 years, will often provide a much lower rate.
5. Consider every applicable loan type
Look at loan types that could apply to you and your purchase. While the conventional conforming mortgage is the most popular mortgage type, it may not be your only option, and it won’t necessarily give you the lowest rate. Across a substantial sample of purchase mortgages I’ve reviewed this year, there are many instances where loan types other than conventional—such as FHA, VA, USDA, and even jumbo—resulted in lower rates when other factors such as down payment, DTI, and credit score were similar. Make the effort to review every loan type available to you.
6. Shop around for your lender
Don’t stop at considering all possible loan types—also look at multiple lenders. Leverage any relationships with financial institutions such as banks and credit unions that already serve you, as they often will offer rate discounts or rate adjustments for being an existing client. Make sure you ask about every possible discount, including adjustments for being paperless (no monthly paper statements) and setting up automatic payments using direct debit.
Consider using a mortgage broker, who can help you choose among multiple lenders.
7. Review costs, fees, and options
Compare closing costs and the annual percentage rate provided in your good-faith estimate. The APR factors closing costs and fees into your quoted interest rate to give you a rate you can compare across lenders.
Also ask about the cost for a discount point, a lock, and a float-down. A discount point is a fee you pay upfront to lower your applicable interest rate.
A lock enables you to lock a quoted rate for a specified time—usually the length of time that will enable you to close, like 60 days.
A float-down is an additional option on a lock that lets you float down an already locked rate to a new, lower rate if the market goes down before you close. Given how volatile rates have been this year, and likely are to be next year, a lock with a float-down offers added flexibility, but it will require a fee.
I know this all sounds painful, but it is worth it. When you score a great mortgage rate, it’s as good as a bases-loaded home run.