A home’s purchase price isn’t the only factor that impacts its cost. The total cost of a home purchase is largely influenced by its mortgage rate. Securing a low mortgage rate can potentially save you tens of thousands of dollars over the lifetime of your loan.
Since your mortgage rate is so important, you may be wondering how to get the lowest one possible. In this article, we’ll explain what factors make up your mortgage rate so you can optimize them accordingly.
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What is a Mortgage Rate?
A mortgage rate is the interest rate that a lender charges on a mortgage loan. Historically, average mortgage rates have ranged from 2.65% to over 18.53%, depending on market conditions. As of October 2023, the average interest rate on a 30-year fixed-rate home loan was 8.00%.
While economic conditions can play a notable role in mortgage rates, personal factors come into play as well. Your mortgage rate may be influenced by your:
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- Creditworthiness
- Debt
- Income
- Down payment
- Loan size
- Loan program
- Lender
Now that you know the basics about mortgage rates, let’s review nine steps to qualify for the best one possible.
1. Raise Your Credit Score
Mortgage lenders typically reserve their lowest rates for applicants who have excellent credit scores. FICO credit scores are broken down into the following ranges:
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- Excellent – 720 to 850
- Good – 690 to 719
- Fair – 630 to 689
- Bad – 300 to 629
Boosting your credit score can reduce your mortgage rate and monthly payments. Here are a few ways to increase your credit score quickly:
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- Make up any missed or late payments
- Pay off any accounts that have gone to collections
- Make sure you make all of your payments on time going forward
- Pay down your credit card balances
- Request credit limit increases on your credit cards
- Keep old credit card accounts open
- Become an authorized user on someone’s credit card account who has excellent credit
- Avoid applying for financing for six months leading up to your mortgage application
- Dispute errors on your credit reports with the credit bureaus (Experian, Equifax, and TransUnion)
2. Reduce Your Debt-To-Income Ratio (DTI)
After your credit score, mortgage lenders often consider your DTI as they set your mortgage rate. This ratio compares your gross monthly income to your monthly debt obligations. If your debt payments take up a large portion of your monthly budget, you may be at a greater risk of falling behind on your mortgage payments. To compensate for this elevated risk, lenders may quote you a higher mortgage rate.
So, how is DTI calculated? Mortgage lenders use two types of DTI calculations during the underwriting process:
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- Front-End DTI – Your front-end DTI is calculated by dividing your housing-related expenses (mortgage payment, property taxes, homeowner’s insurance, and homeowners association fees) by your monthly pre-tax income and multiplying it by 100%.
- Back-End DTI – Your back-end DTI factors in all of your monthly debt payments, rather than just your housing-related expenses. These additional debts may include loans, credit cards, lines of credit, alimony, child support, and leases. Aside from that distinction, the calculation is the same as the one for front-end DTI.
- Front-End DTI – Your front-end DTI is calculated by dividing your housing-related expenses (mortgage payment, property taxes, homeowner’s insurance, and homeowners association fees) by your monthly pre-tax income and multiplying it by 100%.
Most lenders avoid extending mortgages to borrowers who have front-end DTIs above 28%. Additionally, most mortgage programs often have strict back-end DTI requirements, which can range from 35% to 45%. A “good” back-end DTI is between 28% and 36%.
If your DTI is on the higher end, reducing it can help you qualify for a lower mortgage rate. Here are some ways to pay down your debt and lower your DTI:
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- Follow the snowball method – The snowball method suggests paying off your debt balances in order of their size, starting with the smallest one first. After crossing the smallest debt balance off your list, you can pat yourself on the back and use this sense of accomplishment to motivate you as you take on larger balances.
- Follow the avalanche method – A more efficient way to pay down your debt is the avalanche method. With this method, you arrange your debts in order of their interest rates and pay down the highest-interest-rate one first. This approach allows you to pay the least amount of money in interest and potentially get out of debt faster.
- Stick to a strict budget – To make larger debt payments each month, you need to cut back on your monthly spending. You can do so consistently by creating a budget and sticking to it. Spending less may require some sacrifice temporarily, but it will be well worth it when you lock into a lower interest rate.
- Follow the snowball method – The snowball method suggests paying off your debt balances in order of their size, starting with the smallest one first. After crossing the smallest debt balance off your list, you can pat yourself on the back and use this sense of accomplishment to motivate you as you take on larger balances.
In addition to paying down your debt, you can also search for a job that will secure you a higher gross monthly income.
3. Save Up For a Bigger Down Payment
As we’ve touched on already, mortgage lenders carefully consider your risk when setting your mortgage rate. In addition to displaying excellent creditworthiness and having a low DTI, you can lower your perceived risk by making a larger down payment.
A sizable down payment can decrease your loan-to-value ratio (LTV). LTV compares your loan amount to your property’s appraised value. Lower LTVs are less risky to lenders.
If your down payment is 20% or above, you can enjoy the added bonus of eliminating private mortgage insurance (PMI). PMI can cost anywhere from 0.58% to 1.86% of your total loan amount, so it can inflate your monthly housing payments, just like your mortgage rate.
Note: If you’re a first-time homebuyer, ask your mortgage lender about down payment assistance programs. If you qualify for one, it may help you make a larger down payment.
4. Establish a Steady Income and Employment History
While your current financial situation is important to lenders, they also care about your future employment prospects. After all, losing your job or experiencing a dip in your income can make it difficult to afford your monthly mortgage payments.
With this in mind, mortgage lenders will carefully review your income and employment history when you apply with them. They typically want to see that you have two years of stable employment history. They also want to see that your income is steady or increasing, with tax returns, pay stubs, or bank statements to back it up.
Keep in mind that income from self-employment, side gigs, or second jobs may be counted differently than traditional salaries. If your income is volatile or hard to verify, it may increase your DTI and cause lenders to view you as a riskier applicant.
5. Select Your Loan Program Strategically
Different mortgage programs can come with different mortgage rates. For example, conventional loans typically have lower mortgage rates than government-backed programs, such as VA, USDA, or FHA. That’s because conventional loans also have stricter credit scores and down payment requirements.
Likewise, jumbo loans often have higher interest rates than conventional loans. Jumbo loans are used to finance properties that are priced too high for conventional loan programs.
6. Weigh the Pros and Cons of Purchasing Points
Discount points are fees you can pay upfront to reduce your mortgage rate. One point costs 1% of your loan amount. Generally, paying one point can lower your mortgage rate by 0.25%. For example, let’s say you receive a mortgage rate of 7% on a $500,000 mortgage. For $5,000, you can purchase one discount point and bring down your mortgage rate to 6.75%.
Buying points may or may not save you money in the long run. It ultimately depends on how long you intend to stay in the home you buy with the mortgage:
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- If you stay in the home long enough for the interest savings to exceed your discount point fee, it may be worthwhile.
- If you don’t plan to be in the home very long, the point may not be worth the investment.
- If you stay in the home long enough for the interest savings to exceed your discount point fee, it may be worthwhile.
7. Shop Around With Several Lenders
After improving your financial profile and considering discount points, the next step is to find the right lender. Mortgage lenders may quote you different rates, depending on their eligibility requirements.
You can find out if you’re likely to qualify with a lender by applying for prequalification with them. While getting prequalified doesn’t mean you’re formally approved, it can give you an idea of what loan terms and mortgage rates you’ll receive. Based on this information, you may decide to formally apply with one lender over another. Don’t worry—your credit score won’t be impacted by this process.
You can also submit multiple formal applications with your favorite lenders when you’re ready. Just make sure you submit all of these applications within a 45-day window. Doing so will ensure that all of your applications are counted as a single hard inquiry on your credit report. (Hard inquiries can reduce your credit score slightly for a few months).
8. Ask Your Lender About Rapid Rescore
It can take anywhere from 30 to 45 days for the credit bureaus to update your credit reports after you file a dispute with them. As a result, your corrected credit data may not be factored into your credit score right away. If you apply for a mortgage during this interim, you could end up receiving a higher mortgage rate than you would otherwise.
Luckily, there’s a solution to this predicament: Rapid Rescore. This service can expedite credit report disputes and ensure that your credit reports are up-to-date at the time of your mortgage application.
Unfortunately, borrowers can’t use Rapid Rescore on their own. In order to benefit from this service, your lender needs to facilitate the process.
9. Refinance Your Mortgage at the Right Time
After taking out a home loan, you don’t have to settle for your first mortgage rate. You can always refinance your mortgage to obtain a different loan term and interest rate later on.
Refinancing replaces your current home loan with a new one. If average interest rates have dropped or your financial profile has improved, there’s a strong chance you’ll qualify for a lower mortgage rate when you refinance.
Learn More About Mortgages With Certified Credit
As you can see, many factors that impact your mortgage rate are under your control. By optimizing them before you start your home search, you can set yourself up for success.
Want to learn more about mortgages and the home-buying process? Visit the Certified Credit blog. There, you’ll find many educational articles for aspiring homebuyers, including the following:
- What’s a Good Credit Score for a Mortgage?
- Consumer Credit Score vs. Mortgage Credit Score: What’s the Difference?
- How to Build Credit with No Credit History
- What You Need to Know As a First-Time Home Buyer
- First-Time Homebuyer Guide
If you’re a mortgage lender, make sure to check out our mortgage lending solutions. From Rapid Rescore to automated loan origination tools, we offer many products and services at Certified Credit that can help you provide excellent customer service and boost your bottom line.
