Not many home buyers realize they can actually negotiate their mortgage interest rate. Since it is not often that we seek out mortgages, most people are not well versed at the art of negotiations and accept whatever they are offered in term of rate and conditions. Just like any competitive offering, lending institutions can extend attractive options to win the business.
You can get a lower mortgage rate by making a larger down payment, improving your credit score, buying points, reducing your loan term and locking in a rate.
What are your options:
- Make a Bigger Down Payment
- Improve Your Credit Score
- Buy Mortgage Points
- Shorten Your Loan Term
- Lock in a Rate Before Rates Increase
- Learn Where Your Credit Stands Before Applying for a Mortgage
As you've likely heard in recent news reports, the Federal Reserve plans on raising interest rates in March 2022. Already, the market is reacting, with the average interest rate on 30-year fixed-rate mortgages eclipsing the 4% mark in early February for the first time since 2019.
If you're looking to buy or refinance a home, you might hope to snag a lower interest rate on a mortgage now before the next interest rate hike kicks in. You can get a lower mortgage rate by making a larger down payment, reducing your loan term, buying points and keeping your credit in great shape. Here's how.
1. Make a Bigger Down Payment
The more money you put toward your down payment, the better your chances are of scoring a lower interest rate on your mortgage. When you put down a significant percentage of the purchase price, you lower the loan-to-value (LTV) ratio for the home. That's a number lenders use to assess their risk on a loan.
The lower your loan amount is compared with your home's value, the more likely the lender will see you as a safe borrower—and the more likely you'll be to secure a lower interest rate. On the other hand, the smaller your down payment, the riskier a lender will view your loan, which could result in a higher interest rate.
2. Improve Your Credit Score
Your credit score gives lenders a snapshot of your experience managing credit, and they use this information to predict how you might handle credit in the future. Along these lines, mortgage lenders typically view a high credit score as an indicator you'll be a strong borrower and repay your loan as agreed. When lenders are confident you'll be responsible with credit, they're more likely to reward you with lower interest rates on a mortgage.
As a general rule, the higher your credit score, the lower your interest rate may be on a mortgage. If your credit is less-than-ideal, consider taking the following steps to improve your credit score before you apply for a new mortgage loan:
- Make all payments on time. Your payment history is the most significant factor determining your credit score. That's why it's so important to pay every bill on time. Late payments can harm your credit history for up to seven years.
Pay down your credit balances. Your credit utilization ratio lets lenders know how much of your available credit limits you're using. It's also the second most important factor determining your credit score, so you'll want to keep your balances low.
How low? The rule of thumb is to keep your credit utilization below 30%, but the lower, the better—not only for your credit score but also for your financial well-being.
Hold off on applying for new credit. Getting a new credit card or loan just before you apply for a new mortgage is not the best timing. For starters, a small, temporary hit to your credit score is relatively common when you open a new account.
It's impossible to predict how much your score could drop, but a lower score could lead your lender to raise your interest rate. Keep in mind, any increase to your interest rate could cost you thousands of dollars over the course of your mortgage term. To play it safe, don't apply for other forms of credit within three to six months of applying for a mortgage.
- Don't close old credit card accounts. It may be tempting to close old credit cards, especially if they have an annual fee. But if your goal is to build good credit, consider keeping old accounts open because they can help keep your credit utilization low. As for the annual fee, consider asking your card issuer if you can downgrade your current card to one without an annual fee if you don't get a lot of use out of your current card.
3. Buy Mortgage Points
Buying mortgage points, also known as discount points, is a wise way to lower the interest rate on your mortgage. Mortgage points are fees you pay directly to your lender in exchange for a reduced interest rate on your home loan.
Generally, each point costs 1% of the loan amount, so one point on a $400,000 loan would run you $4,000, which is due at closing. In return for buying points, the lender will lower the interest rate on your mortgage. The amount of rate discount you'll receive varies depending on the lender, the type of loan you're getting and market conditions.
Before you buy points, run the math to determine the breakeven point—the number of months it will take for your total savings to add up to the cost of the points. If the time until the breakeven point is longer than you plan on owning your home, buying mortgage points may not be worth it for you.
When you review your loan estimate, you may see two different types of points: mortgage points (also known as discount points) and lender credits. These two types of points benefit two different types of buyers.
If you plan on living in your home for a long time, you might purchase mortgage points to lower your mortgage rate and save money in the long run. But, if you're a short-term buyer, you may consider opting for lender points. In this case, you agree to pay a higher mortgage interest rate in exchange for lower costs at closing, which can be helpful if you want to buy a home with the lowest upfront costs.
4. Shorten Your Loan Term
You can usually qualify for a lower interest rate if you shorten your loan term from, say, a 30-year loan to a 10-year or 15-year mortgage. Short-term loans typically have lower mortgage rates because they are less risky for the lender. If you've found your long-term home, and you can comfortably manage the payments, consider getting a shorter-term loan to pay off your home sooner.
5. Lock in a Rate Before Rates Increase
The closing process can take several weeks, and interest rates can fluctuate during that time. Once you sign the purchase agreement and are approved for a home loan, talk to your lender about locking in your mortgage rate. By doing so, your interest rate will stay the same, regardless of what happens in the market. You may have to pay a fee to lock in a rate, but not always.
Remember, though, just as a rate lock prevents your interest rate from changing when interest rates rise, it could also mean you'll miss out on a better rate if interest rates decline. Before you agree to a rate lock, ask your lender about getting what's called a float-down option. A float-down option allows you to take advantage of a lower rate if interest rates fall while protecting you from rate increases. There is a catch, of course: You'll likely have to pay an extra fee for a float-down option.
Learn Where Your Credit Stands Before Applying for a Mortgage
It's good practice to find out what your credit looks like before applying for a mortgage. You can check your credit score for free with Experian; you can also opt to get the scores that mortgage lenders use. If your credit score is already above 700, you may not need to make many improvements before applying for a mortgage preapproval.
But, if you suspect your credit score is too low to qualify for a mortgage with lower interest rates, consider getting a copy of your credit report from Experian to spot potential credit issues. If you find any information you believe to be erroneous or fraudulent, immediately dispute the information with the three major credit bureaus, Experian, TransUnion and Equifax.
By Tim Maxwell