Mortgages are a part of modern life, and though no one wants to owe money, mortgages are necessary to help you afford your new home. However, you don’t have to make massive changes to your spending just because you are borrowing money. Shopping around to secure the best interest rate possible can save you a lot in the long run.
Saving Money with a Better Mortgage Rate
Now let’s say you need a mortgage for a house worth $220,000, and you can put down the standard 20% down payment. If you can secure an annual interest rate of 3.56% on a 30-year fixed term loan with monthly payments of $1,173, you will end up paying around $286,000 in total. Now, if you take those same numbers and apply them to the same term for the loan, but with an interest rate of 4.60% with monthly payments of $1,284, you will pay around $324,000. That is approximately $38,000 saved because of the better interest rate. Here is a calculator to help you work out your possible savings.
A better interest rate won’t just save you money; it will also allow you to stretch your budget a bit further. You may have planned to pay a certain amount per month but then managed to get a lower than expected APR. If you want to stick to your original budget, you can increase your mortgage amount and buy a bigger and better home.
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Interest Rate vs. APR
On your search for a mortgage, you will often see two different mortgage rates; the interest rate and the annual percentage rate or APR. They are not the same, and understanding the two is a crucial step in ensuring a good mortgage.
Interest Rate
The interest rate for a loan is usually the advertised mortgage rate that is used to calculate the additional amount on top of your home loan. For example, using the same property worth $220,000, you make the 20% down payment, which is $44,000, which leaves you needing a mortgage for $176,000. A bank or a credit union (such as amhfcu.org) could lend you money the money you need based on your interest of 3.56%. Every month you will pay $517.61 just in interest and over the 30-year term that adds up to $110,000 spent on interest. You should not ignore an interest rate as it still adds on to the cost of a mortgage. Lower is always better when it comes to saving money.
APR
The interest rate is usually advertised first because it is lower and more enticing, but the APR is what you need to pay attention to. The APR is the total combined fee of a mortgage. When a lender is offering you a mortgage, they take all of the costs that come with it and add it to your borrowed amount. Such expenses can include the non-recurring closing costs, such the broker fees or origination fees, as well as mortgage insurance, home insurance, appraisal fees, and any other fees. The money for insurance is not needed immediately but is still taken by the lender and held in an escrow account until required.
Fixed-Rate Mortgages vs. Variable-Rate Mortgages
As well as the interest rate and APR, you will also come across fixed-rate and variable or adjustable-rate mortgages while looking for mortgages that suit you. Fixed-rate and Variable-rate mortgages are the two primary types of mortgages. Each offer comes with multiple variations that include different amounts of time allowed for a fixed-rate loan to how long until the mortgage rate changes on a variable-rate loan. The basics that you need to know are listed below:
Fixed-Rate Mortgages
As the name implies, fixed-rate mortgages give you one APR rate and don’t change throughout the term of the loan. The amount you pay per month stays the same, and it is made up of both the interest and the principal amount. As you get further into your monthly mortgage payment terms, you will pay more on the principal amount. The principal amount is the actual price of the property, meaning you will be paying less towards the interest. Paying off the principal amount will help you build equity in your new property. The process of building equity is called amortization. A longer-term for a fixed-rate mortgage means it will take you longer to own more of the house.
Despite this fact, however, of all the terms offered for a fixed-rate mortgage, 30-years is the most popular choice among first-time home buyers. The popularity comes from the fact that the monthly payments are less than other terms. In the long run, you are paying more than you would on a 15 or 20-year fixed mortgage. A shorter-term comes with a higher APR because you have to pay off the same mortgage in less time. If you can afford the higher payments on a shorter-term without getting into debt, then you will find yourself spending much less overall.
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Variable-Rate Mortgages
The interest rate for a variable or adjustable rate mortgage-ARM, is as the name implies, variable. On the ARM, the interest rate is set lower than the interest rate of its counterpart, the fixed-rate mortgage. The interest rate, however, may start to rise after a set period and, depending on the terms, become higher than that of the fixed interest rate. Rate changes will usually not happen straight away. There will be an agreed period where the loan will stay fixed at a lower rate. This period can be just one month, or it could be ten years. Generally, the shorter the fixed period of interest, the lower the interest rate will be.
When considering an ARM, you need to look at the adjustment frequency, because the interest rate could change every month or every year. The lender has no say on the adjustments as they are bench-marked to a financial index such as the federal cost of funds index. For that reason, today’s rates may not be the same as tomorrow’s, and even the actions of the federal reserve can affect your mortgage rate. You will also need to pay attention to the interest cap. The cap refers to the limit of how much the interest rate can rise each time it is adjusted. There is also a ceiling, which is the maximum amount the interest rate can ever increase to.
Interest-Only Mortgages
Another type of mortgage you should know about is the interest-only mortgage. These mortgages are not as available as before, and the mortgage lenders that do offer them will have higher criteria for you to meet. The idea is that you only pay the interest amount for the agreed term and then cover the principal amount at the end of that term. Such loans are generally a bad idea. The low monthly payment can leave you with the worst-case scenario of being tempted into buying a home you actually can’t afford.
What Can I Do to Get a Better Rate?
Homes are expensive, hence the need for a mortgage. Everyone wants to spend as little as possible, and that means securing a better interest rate. There are steps you can take to make sure you approach your lender with the best chance of getting a low mortgage rate. Some of the steps you can take are:
Improving Your Credit Score
Your reliability as a borrower is one of the main factors to affect your offered interest rate. Lenders often judge your credibility by your three-figure credit score. A higher score indicates to a lender that you are more trustworthy. A good score to aim for is between 670 and 739. Such a score isn’t a bad score, but it’s not great either. An average rating will offer you average mortgage interest rates. Aiming for an excellent score of 800 or higher will provide you with the lowest mortgage rates possible. If you have a score below 670, then you need to put some work in before applying for a mortgage.
To improve your credit score, you should pay your bills on time and keep up with your credit card balances. The more outstanding balances you have, the more it will negatively affect your score. You should also check your credit report at all three credit reporting agencies. When you receive your report, check it for errors and report them back to the agency. Correcting any mistakes can raise your credit score. Lenders are stricter than ever after mortgage-backed securities or MBS led to the 2008 financial crisis, so keep in mind that a high credit score will go a long way.
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Save Up for a Down Payment
The example above uses a down payment of 20%. Such an amount is the usual requested amount from a loan issuer if you want to avoid premium mortgage insurance or PMI. If you can’t afford 20%, then a lender can offer to accept a down payment as low as 3%. For that decrease, there is a need for PMI. You can expect the insurance cost to be between 0.5% and 1% of the total loan amount. The higher the down payment amount you have, the lower your loan-to-value ratio will be, and the less you will have to pay for the actual mortgage.
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Seek Out a Shorter-Term Mortgage
As stated above, a shorter loan is cheaper in the long run. If you can afford the higher payments, then you should go for a short-term loan, such as a 15-year fixed mortgage loan. Using the above example with the average for today’s mortgage rate on a 15-year term at 3.44%, you would only pay $49,543 in interest. That is $60,000 saved on interest because you fit your mortgage into the 15-year term instead of 30 years.
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Consider an Adjustable-Rate Mortgage
A traditional mortgage may not be the best option for everyone, and one alternative is an adjustable-rate mortgage or ARM. Permanently fixed-rate mortgages might not be the ideal option. However, if you know your new house is not your final home, you can make use of the fixed period of lower interest payments. Perhaps you secure a better income so want to upgrade to a new house. What you can do is refinance your adjustable-rate mortgage into a fixed-rate mortgage and only pay minimal costs. Mortgage rates are variable, which means they can drop as well as increase. Though it is a risk, you might find yourself with lower mortgage rates than fixed-term borrowers can only dream of.
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Lock in Your Rate
Finalizing the sale of a house is not something that happens overnight. The closing process can take weeks or even months. In that time, you might find that the interest rates that initially caught your interest have raised or dropped. Interest fees are subject to change daily. If they go down, then that’s good. However, what happens if, during the closing process, you find a much lower interest rate? Missing out on this opportunity may sting for some, but if you decide that you like your current plan, then you can ask your lender to lock in your rate.
Locking your rate will hold it from when you requested it up until closing on your house sale. Most lenders will charge a fee for securing an interest rate. You should also check your terms as some also offer the chance to withdraw from the locking agreement. Such clauses mean that if the average rate does drop below what you locked for them; you can opt for the lower rate. You will still have to cover the lock-in as it is a non-refundable fee.
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Buy Discount Points
Discount points are not an option for everyone and are only really worth your time if your loan is long-term. A borrower can buy discount points that reduce the interest rate. They do not come cheap with 1 point, typically costing about 1% of the total loan amount. One point will usually see a decrease of 0.25%. It can take up to nine years to see your investment returned.
Check to See if You Qualify for Alternative Mortgages
The standard mortgages discussed so far are conventional loans though there are alternatives available if you meet the requirements. Let’s go over some options.
FHA Loan
An FHA loan or Federal Housing Administration loan is a government-issued loan intended for people with lower income and lower credit scores. An FHA loan will also accept a small down payment of 3% though you will have to pay mortgage insurance premiums. Due to lower requirements, less money is available, and the loan is only valid for purchasing a primary residence. Such a loan may not offer a lower rate but does open up housing options to you if you don’t have the upfront capital. Such terms can be excellent for first-time buyers.
VA Loan
A Veterans Affairs or VA loan is also a government-funded loan. If you are a current or ex-service member, then you should look into this form of financing. Some lenders will need no down payment nor require insurance. You can also expect a low-interest rate with a VA Loan. Further assistance comes in the form of grants for those who sustained a permanent disability while serving.
USDA Loan
A United States Department of Agriculture loan requires no down payment from eligible home buyers while also securing low-interest rates. Rural locations are the best place to make use of this loan though it can extend to some suburban areas. To qualify for a USDA Loan, you need to be a permanent resident. You must also have a dependable income consisting of two consecutive years, hold an acceptable debt ratio, and a credit score of 640 or above.
Shop Around
With any purchase you make, you should always shop around for the best offers. Sit down and research to find the best offer available to you. Don’t just head down to your local bank and settle for their proposal. Shop around online using multiple third-party website comparisons. Talk to numerous lenders and try to get as many offers as possible. If you find one that you like but get denied, you won’t regret having a backup option.
Credit agencies even encourage you to apply to multiple lenders. Each application should count as a hard credit pull, which can hurt your credit score. However, you are given up to two weeks to make as many mortgage applications as you like, with it only counting as one credit pull.
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Everyone Deserves a Good Deal
Getting a good deal on your mortgage rate can make future repayments much easier to deal with. It isn’t just the interest fee you should consider but all the other costs that make up the APR. If you have the funds to take on a shorter financial commitment, then you should. You can save a whole lot of cash in the long run. If you don’t have a high budget, then check out alternative loans.
No one mortgage is right for everyone, so take the time to weigh up what you want versus what you can afford to ensure you will be in an excellent financial situation.
Do you have any tips for lowering an interest rate? Do you wish you knew some of the things mentioned above when shopping for a loan?
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