Interest rates are nearing a record low as a response to the Federal Reserve’s moves to encourage consumer spending. The Fed issued emergency rate cuts in March as a preemptive strike against a plunging market in the wake of COVID-19.
While the Federal Reserve does not set mortgage rates, their move will affect a variety of spending tools, including mortgage loans. If you’re thinking about taking advantage of lower interest rates, here are a few things to keep in mind.
Shop, shop, shop
One of the biggest mistakes that homebuyers make is failing to shop around for the best mortgage terms. Many accept the first lender who agrees to offer them a home loan without finding out if they could get a lower interest rate, fewer fees, or different repayment terms. To see what kind of rates you qualify for today, check out this free online tool.
A common misconception is that shopping for a mortgage rate can hurt your credit score. While too many inquiries on your credit report can drop your score, reporting agencies will group like-inquiries, so shopping for a car loan or a home loan is less likely to cause a significant drop in your credit score.
Use a comparison website, like Credible, to look at different lenders and compare fees, rates, and repayment terms to determine which lender offers the best deal for your family.
Get your credit in order
To qualify for the best interest rates, you’ll need a credit score of at least 700. While you could be eligible for an FHA loan with a score in the 500s, many lenders are tightening their requirements and raising their interest rates for borrowers with lower scores. If you are confident in your credit score, then consider moving forward by using Credible to compare rates and see what kind of loans you are eligible for.
If you need to raise your credit score focus on the following areas to have the biggest impact:
- Total debt balances compared to available credit (how much of your credit lines are you using)
- Debt-to-income ratio (how much of your monthly income goes towards debt)
- Payment history (How often are you late? Do you have any bills in collections?)
- Errors or inaccuracies (Are there any accounts reporting incorrect balances or payment histories?)
Build up your down payment
While the Federal Reserve did reduce interest rates to encourage consumer spending, many lenders are raising their lending standards. Lending companies know that the economy is fluctuating right now, and they want to protect their investments. To improve your chances of qualifying for better interest rates, take the time to save up at least 20 percent for a down payment. If you have a lower credit score, you may want to consider saving even more.
If you provide at least 20 percent toward your home purchase, your lender likely won’t require private mortgage insurance, which can reduce the cost of your mortgage payment too.
Consider a different term than 30 years
A 30-year mortgage is a popular option for many homebuyers because the monthly payments are smaller. However, longer repayment terms typically have higher interest rates, which means the total cost of the home over the life of the loan is more expensive.
For example, let’s look at a mortgage loan for $250,000.
Option one is a 30-year fixed-rate loan at 4.5 percent. The monthly payments on this loan would be about $1,267. The total interest paid over 30 years would be $206,017.
Option two is a 15-year fixed-rate loan at 4.5 percent. The monthly payments on this option would be $1,913. The total interest paid over 30 years would be $94,247.
The 15-year loan is more than $100,000 less expensive, and that’s not factoring in a potentially lower interest rate you’d likely qualify for since lenders view shorter repayment terms as lower risk.
Check out the Credible loan calculator to get numbers for your specific situation.
Have steady income/employment
Lenders look for borrowers who have steady employment or a constant source of income. They want to ensure that they’ll get their money back. Lenders will request a two-year income history. Income history includes pay stubs, tax forms, and job history. If there are any gaps in your employment, you’ll need to be at your current job for at least six months.
To summarize, borrowers who meet the following criteria are more likely to qualify for the best interest rates:
- Steady employment for at least the last six months
- 20 percent or more to put towards a down payment
- A credit score of at least 700
- Clean credit history
- Willing to consider a 15-year loan
- Buying a home in an affordable area
You may still qualify for a mortgage loan even if you don’t meet all these requirements, but you’ll likely have higher interest rates. Use a comparison tool, like Credible, to search for lenders in your area that offer the best rates.