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How To Get A Low Rate Mortgage

With a FICO score of 720 or above, you’re in a position to get the best mortgage interest rate, and in turn save hundreds of dollars a month on loan payments. But it doesn’t pay to obsess about achieving a perfect score once you’re in the upper echelon. Instead, to reap the full benefits of being a low-risk borrower, it’s important to understand what considerations go into your credit score, and how lenders interpret the data to determine your mortgage interest rate.

 

Mortgage Interest Rate and Credit Scores

Often referred to as a FICO score (for the Fair Isaac Company, which created one of the best-known credit formulas), the score measures a combination of how regularly you pay your bills, live within your means, and manage debt. Of all the considerations, lenders pay closest attention to your history of payments, says David Jones, president of the Association of Independent Consumer Credit Counseling Agencies. “If there was one thing I’d tell consumers, it’s to pay every bill on time,” Jones says. “Do it religiously and don’t make minimum payments.”

It may sound obvious, but the key to a low interest rate is credit score stability, and creditors’ priorities reflect that. While different reporting agencies may vary slightly in the how they weigh the various factors (FICO is not the only measurement used by the three major credit bureaus), credit scores are based on five key elements:

Paying bills on time: 35%

Debt-to-credit-limit ratio: 30%
How long you’ve had the credit: 15%
Pursuit of new credit: 10%
Types of credit used: 10%

 

Have 6 Months of Stable Credit History for a Lower Interest Rate

To present a picture of financial stability, Jones suggests that homebuyers take at least six months to get their finances in order before applying for a mortgage in order to get the best mortgage interest rate. In this economy, risk managers are looking in the strangest places to analyze your spending habits — including the grocery line. “If you never buy your groceries with a credit card, and then you suddenly start using it, that’s a red flag,” Jones says. Some of his clients were surprised to find that their interest rates had gone up because of changes in their spending patterns. And while something as mundane as grocery shopping may not directly affect your mortgage interest rate, he says that an accumulation of such minor discrepancies could hurt a lender’s faith in you.

Unfortunately, stability can come at a high price, as even some positive changes in your finances can shake your lender’s confidence. Part of what goes into the credit algorithm is the time you’ve spent working at your job. So while changing jobs for a pay raise might seem like a no-brainer, if you’re expecting to apply for a mortgage within the next year, you may want to hold off until you’ve secured a good mortgage interest rate.

 

Keep a Low Debt-to-Credit-Limit Ratio

You should never use more than 50 percent of your total credit limit, says Dorothy Guzek, a financial counselor for GreenPath Debt Solutions, a nonprofit credit counseling agency. In fact, she says, using 40, 30, or even 5 percent is even better. In other words, the total debt you owe on any account should never approach the total credit limit. This is because credit formulas divide the sum of your balances by the sum of your credit, and use this number to judge how well you live within your means. Just because you have a high credit limit doesn’t mean you should prove that you need all, or even most of it. Mortgage lenders see such spending as the sign of a high-risk borrower and therefore set higher mortgage interest rates for frequent offenders — if they lend to them at all.

 

Opening and Closing Accounts

At the same time, don’t panic and start shuffling cards in an attempt to artificially change your ratio — you’ll only cause more damage and potentially hurt your chances of getting a low mortgage interest rate. Closing credit cards without a balance, for instance, reduces your total credit limit, and therefore worsens your debt-to-income ratio. If you close your oldest card, your credit history becomes younger, which hurts your long-term reliability. Finally, if you open up new cards in the six months prior to applying for a mortgage, it suggests to lenders that you’re having trouble paying bills and that will also ding your score. So, serial shoppers should beware of department stores that offer membership credit cards in exchange for discounts. These too can prevent you from getting a low mortgage interest rate when applying for a home loan.

 

Diversify Your Credit History

One way to help ensure you’ll get the best mortgage interest rate is to show your lender that you can handle a variety of loans, including fixed payments (mortgages, car payments, student loans) and revolving credit (credit cards). The best way to stay current with your balances is to sign up for automated bill payment. Provided you haven’t charged more than you’re capable of paying, you’ll never suffer another late payment again.

 

Renters, Take Heed


There are some individuals with credit scores in the high 700s, who won’t qualify for the best mortgage interest rate because of past indiscretions on their credit report. In a growing number of cases he’s seen, larger landlords are reporting their tenants’ rent-payment records. “Any creditor can deal directly with the three major credit bureaus,”. So treat your landlord like you would your lender. By the same token, if you always were on time with rent payments you should request that your landlord submit a positive report to the credit bureaus; it will make you more appealing to lenders, especially if you don’t have very established credit.

 

Beware “Credit Repair”

“When you hear someone say they can improve your credit in a short period of time, you oughtta run for the hills,”. While some people have tried to game the system and artificially inflate their credit score in the hope of getting a lower mortgage interest rate, these efforts are usually made in vain, and for a hefty fee. “It’s not just the FICO score. Lenders look at the credit report [when deciding the mortgage interest rate],” he says. It’s more important to avoid behavior that indicates job loss, or some other financial instability. Throughout the plodding process of preparing one’s credit, patience is a virtue. There is no substitution for establishing a long track record of reliability.

 

Get Your Credit Report and Check for Errors

The federation of U.S. Public Interest Research Groups found that 79 percent of credit reports have a serious error or other mistakes, and one in four reports has an error so bad that it could prevent someone from getting credit at all — let alone a low mortgage interest rate. To prevent this from happening to you, visit AnnualCreditReport.com, the only site sponsored by the three credit bureaus, and note any errors you find. You are entitled to an annual free report from each of the three credit bureaus: Experian, TransUnion and Equifax. To track your score over time, while also searching for discrepancies between the three reports (as they each use slightly different formulas), staggering the reports over the course of the year — one every four months.

One way to test whether you’re ready to make the move, is to determine just how much you’ll be spending monthly in addition to your mortgage payments. Once you’ve added up your projected mortgage payment and all your other budgetary items (be honest), put this money aside for three to six months in a savings account. If you find that you need to dip into it for emergencies, you can’t yet afford your new payment, she says. But if you can comfortably get by without touching the account, you’re not only ready for your mortgage, you’ve also built up a handsome hunk of change toward your down payment.

 

Three Steps to Getting a Mortgage

Shopping for a mortgage is the first step toward owning a home and perhaps the most daunting, especially if you are not prepared.

Once a simple task that meant comparing fixed rates from among perhaps a dozen or fewer savings and loan companies, the mortgage hunt today is like finding your way through a maze.

There are dozens of loan types and hundreds of loan programs available through thousands of mortgage brokers, bankers, lenders, finance companies, credit unions and even stock brokerage firms.

Contrary to popular belief, finding a mortgage doesn’t begin with an application.

Education is a better first choice. Mortgage information sources are as vast as the number of mortgages available. Web sites, topical newspaper articles, mortgage books, consumer seminars and workshops, financial planners, real estate agents, mortgage brokers and lenders are all available to assist you along the way.

First, you must determine how your mortgage payment will fit your current budget and, to some extent, your future obligations 15 to 30 years down the road.

If you discover too late that you can’t afford your mortgage, you’ll not only face the possibility of losing the roof over your head, but you could also damage your ability to purchase a home later.

Step 1: Examine your finances

Start by determining how much mortgage you can afford. Lenders are apt to put your loan application in the best light and qualify you for as much as they are willing to lend, which can be more than you can afford or need.

It’s up to you to take stock of your income and expenses, current and projected, to determine what you can comfortably manage each month. Along with your mortgage payment, don’t forget related insurance, taxes, homeowner association dues and any other costs rolled into the mortgage payment.

Step 2: Shopping for a loan

When you are ready to shop for a loan you have two basic types of mortgage stores to shop — direct lenders and mortgage brokers.

Direct lenders have money to lend. They make the final decision on your application. Brokers are intermediaries who, like you, have many lenders from which to choose. Lenders have a limited number of in-house loans available. Brokers can shop many lenders for each lenders’ store of loans. If you have special financing needs and can’t find a lender to suit them, an experienced broker may be able to ferret out the loan you need. Mortgage brokers, however, are paid from the amount you borrow. The amount varies. Mortgage brokers are a lot like real estate agents, make sure to go with someone who is recommended and has been in the business a substantial amount of time. Internet brokers perhaps receive the smallest cut, sometimes none at all, and can prove to be a real bargain.

Don’t just go with the lowest interest rate. There are many other factors that affect the true cost of the loan, inlcuding broker fees, points (each point is one percent of the amount you borrow), prepayment penalties, the loan term, application fees, credit report fee, appraisal and many others.

Step 3: Apply for a loan

The application process is the easy part — provided you’ve gathered documents necessary to prove claims you make on the application.

The application will ask for information about your job tenure, employment stability, income, your assets (property, cars, bank accounts and investments) and your liabilities (auto loans, installment loans, mortgages, credit-card debt, household expenses and others).

The lender will run your credit report to look at your FICO scores, which are very important when it comes to rates and terms you will be offered. You will also likely have to supply additional documentation, including paycheck stubs, bank account statements, tax returns, investment earnings reports, rental agreements, divorce decrees, proof of insurance, among other information. If the lender deems you creditworthy, it will likely hire a professional appraiser to make sure the value of the home you want to buy is worth your purchase price.

 

Questions to Expect From Mortgage Lenders

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Know what to expect before you apply

Your mortgage lender will want to know a lot about you before approving your loan application, and justifiably so; they and their underwriters want to be assured that you meet their minimum level of creditworthiness before lending you money.

Areas of questioning

Here are the general areas of questioning you can expect from a lender:

1. Employment and income
2. Outstanding debts
3. Cash reserves and assets
4. Down payment
5. Loan purpose
6. Property use
7. Property type

Employment and income

  • Where do you work?
  • How much do you make?
  • How long have you been at your job?
  • How is your income derived — steady salary or irregular income? If it’s the latter, you may need to provide more details to obtain a favorable interest rate.

Outstanding debts

  • What recurring debts do you have?
  • How much do you pay a month for auto loans?
  • Credit cards? How much of your monthly pretax income do these debts consume?
  • Cash reserves and assets
  • How much money do you have in the bank?
  • How much will be left after you pay your down payment and closing costs?

Down payment

  • How much money are you putting down?
  • Is this your own money?
  • If not, is it a gift from your parents?
  • A nonprofit agency grant?

Loan purpose

  • Is this mortgage for a home buy or refinance?
  • If it’s a refinance, do you want to take cash out at closing to pay off other debts? If so, how much?

Property use

  • Do you plan to live in the house?
  • Is it investment property?

Property type

  • A condominium?
  • A duplex?

The following responses tend to work in your favor:

  • Steady employment (two or more years) with the same employer or in same line of work.
  • Low debt: no recent major buys (such as automobiles) and a debt-to-income ratio of 36 percent or less.
  • Loan is for straight home purchase (or rate-and-term refinance).
  • Property is detached single-family home to be used as primary residence.
  • Down payment of at least 5 percent of sales price with your own money.
  • You’ll have at least two months’ worth of mortgage payments in the bank after closing.

These responses tend to work against you:

  • Self-employed or contract worker.
  • High debt: credit cards maxed out, total debt-to-income ratio more than 36 percent.
  • Property is a duplex or condominium, to be used as a vacation home or rental.
  • No cash left after home buy and closing costs.
  • Down payment is 3 percent or less of buy price and money is borrowed.