If you’re planning to buy a new home, there are a few things you can do to save yourself a bundle of money before even walking into your first open house. By positioning yourself to get the lowest interest rate on your home loan, you can save thousands of dollars over the life of the mortgage.
For example, if you’re looking to purchase a home for $200,000 and you have $40,000 for a down payment, the difference between a 5 percent and 6 percent interest rate on a $160,000 mortgage ($200,000 purchase price minus $40,000 down payment) over 30 years is in the neighborhood of $35,000. With that in mind, here a few steps to a lower mortgage rate:
Improve your debt-to-income ratio.
Your debt-to-income (DTI) ratio is determined by dividing your gross monthly income by the amount of debt you are obligated to pay each month. These debts typically include items like auto loans and student loans. Credit card debt is also included, but only the minimum amount due each month is used in the calculation.
Most mortgage lenders would like your DTI to be under 30 percent to issue an appealing interest rate. If you figure out that your DTI is above the prescribed percentage, there are a couple steps you can take to lower it. The first would be to increase your income. Unless you add a co-signer to your loan, this is obviously easier said than done. So the more realistic option might be to reduce your debt by paying down some of your outstanding loans.
[Mortgage Help: Get your free credit report and see if your credit score is mortgage qualified]Improve your loan-to-value ratio.
The other key ratio when applying for a home loan is the loan-to-value (LTV) ratio. This is calculated by dividing the amount you want to borrow by the price of the home you want to buy. From the previous example, the amount of the loan is $160,000 and price of the home is $200,000. Therefore, the LTV is 80 percent, which is often the threshold that lenders are looking for borrowers to clear. If your LTV is more than 80 percent, you may still be able to qualify for a home loan, but you will likely face additional expenses, such as having to pay private mortgage insurance on your loan.
There are two simple ways to lower you LTV. You can either save more money to increase your down payment or find a less expensive house to purchase. Of course, you could also choose to utilize both of these options equally to improve your LTV. The specifics of your personal situation will dictate which of the options are the best course of action.
Improve your credit score.
Maybe most importantly, mortgage lenders look at your credit score to determine an interest rate for your loan. First, you should check your credit scores with each of the three credit agencies: Equifax, Experian, and TransUnion. Typically, a credit score above 650 should be good enough to secure a decent interest rate. Of course, the higher you credit score is, the more likely that you’ll be offered an even lower rate. Given that fact, all potential home buyers, with good and bad credit alike, should be actively trying to improve their credit score.
Unlike the previous two categories, there is not an exact science to calculating your credit score, because there are a plethora of factors that go into computing it. However, here are a few reliable techniques that have been proven to improve your credit score over time.
- Make your payments on time each month. Late payments are the most common contributor to a poor credit score. Luckily, it is an aspect that is within your control. If you need to focus more attention on paying your bills on time, it is well worth the effort.
- Dispute negative inaccuracies on your credit report. Review your credit reports for mistakes and dispute any information that is incorrect with the appropriate credit bureau.
- Only use the credit that you need, but keep all that you have. The higher your credit lines or limits and the lower your balances, the more credit agencies will find your report attractive. So even if you have no plans to use a credit card you have open, don’t cancel it. If nothing else, keeping that credit limit on the books will help your credit score.
- Avoid unnecessary credit inquiries. Each time you apply for a new credit card, your credit score takes a minor hit. If you are concerned about your credit score, it’s best to limit your credit applications to those that are truly essential.
Essentially, the tips above boil down to some strategic belt-tightening in the short-term that will hopefully save you thousands of dollars in the long haul.