Don't look now, but mortgage rates are rising, which is typically bad news for prospective homebuyers as it increases both their monthly payments and what they'd expect to pay over the life of their loan.
According to Bankrate, as of Dec. 4, the average 30-year fixed mortgage was 4.13%. Comparatively, a month before, the 30-year mortgage rate averaged just 3.51%, a difference of 62 basis points. If you're planning to take out a $200,000 loan over 30 years, the total cost of a mortgage at 3.51% would be $323,714 compared to a total cost of $349,157 at 4.13%. That's more than a $25,000 difference in a matter of a month (or about $71 extra per month), and this estimate doesn't include the fees and points you might pay to originate your home loan.
With the likelihood increasing that the Federal Reserve will boost interest rates in December and stick with its policy of monetary tightening, at least in the near term, the reality is that mortgage rates could rise even more. This means prospective homebuyers need to be extra diligent in their efforts to secure a low mortgage rate.
Here are seven ways you may be able to snag a low mortgage rate even with interest rates on the rise.
1. Use your credit score as a bargaining tool
One of the smartest things you can do prior to searching for a home is to maintain a good or excellent credit score. Your credit history is closely analyzed by mortgage lenders since a home is arguably the biggest purchase you're ever going to make.
There are five factors that influence your credit score, although the precise formula is a closely guarded secret. According to FICO, your credit score is based on the following factors (along with their importance in parenthesis):
- Payment history (35%)
- Credit utilization (30%)
- Length of credit history (15%)
- New credit accounts (10%)
- Credit mix (10%)
Or in simpler terms, if you pay your bills on time, don't use more than 30% of your aggregate credit available, keep your good-standing accounts open for a long time, avoid opening too many new accounts, and demonstrate that you can handle installments loans and revolving credit, then you're liable to have a favorable credit score.
If you do have a good credit score (usually 720 and higher), you may be able to use your responsible payment history as a bargaining tool to get a lower mortgage rate. The higher your credit score, the more banks will fight for your business and perhaps undercut their competition.
2. Shop around
Another step you should strongly consider taking is to shop around with numerous lenders to see which one will offer you the best rate. Amazingly, a Consumer Financial Protection Bureau survey of 2013 mortgage borrowers found that nearly half of all homebuyers failed to shop around and only considered a single lender. Applying with only one lender would almost certainly limit your chances of getting the best rate possible.
If you have a prime, near-prime, and, in rarer cases, a subprime credit score and you're looking to buy a home, allowing lenders to go head-to-head to earn your business is often a smart tactic to securing the lowest mortgage rate possible.
3. Try your local credit union
Aside from perusing a handful of lenders, prospective homebuyers would be wise to visit a local credit union or two in their search for the best mortgage rate. Credit unions not only have a more hometown feel to their way of doing business, but they also have fewer or lower fees than most national banks, meaning you may be able to snag a lower mortgage rate or perhaps lower mortgage origination fees (leading to a lower APR if rolled into your loan).
Furthermore, credit unions are far more likely to work with prospective homebuyers with less-than-stellar credit and they're also more likely to retain your mortgage loan instead of selling the servicing of your loan to another party.
4. Put more money down
A pretty simple solution that could help lower your mortgage rate is to consider a larger down payment. The more money you're willing to put down up front, the more comfortable a lender is liable to be when giving you a loan. And the more comfortable you can make a lender, the more likely they are to offer concessions in the form of a lower mortgage rate.
As an added bonus, putting at least 20% down on a home can exempt you from having to pay primary mortgage insurance, or PMI.
5. Shorten your loan
Instead of putting more money down on your home purchase, another option to lower your mortgage rate is to shorten the length of your loan from a 30-year traditional mortgage to a 15-year one. Your monthly payments will be higher, but there's also less perceived risk for the lender if you take a shorter-term loan.
According to Bankrate, the average 15-year mortgage rate as of Dec. 4, was 3.39%, providing 74 basis points of savings over the 30-year mortgage. Although your monthly payment would be about $520 higher with a 15-year loan (based on the previous example of a $200,000 home loan) compared to a 30-year home loan, the total cost of your mortgage would be almost $94,000 less!
6. Consider an FHA loan
Select homebuyers may also benefit from an FHA loan, named after the Federal Housing Administration. FHA loans can sometimes qualify for lower mortgage rates than conventional home loans, and they almost always have lower down-payment requirements. If you qualify for an FHA loan with a credit score of 580 or higher, you may be able to get away with only putting 3.5% down. People with FICO scores ranging from 500 to 579 can qualify for an FHA loan, too, although they'll need to put at least 10% down.
However, one thing to consider with an FHA loan is that you'll likely have to pay PMI on your loan until you reach 20% equity in your home. PMI is designed to protect your lender in case you don't make your payments, and should be factored into your monthly home costs when you consider buying a home with less than 20% down.
7. Consider an adjustable-rate mortgage
Finally, it may be worthwhile in some instances to consider an adjustable-rate mortgage, or ARM. An ARM offers a below-market mortgage rate for anywhere from three to seven years, upon which the rate a homeowner will pay goes higher based on interest rates at the time of the adjustment. For prospective homeowners with very large down payments and the real prospects of paying off their home in less than 10 years, an ARM could be an option to consider.
However, generally speaking, ARMs can be far more trouble than they're worth. If interest rates move against you in a meaningful way, you could be stuck with a substantially higher monthly payment than you'd bargained for. Unfortunately, there's just no way to predict where interest rates will go with any certainty, meaning if you're planning to take more than 10 years to pay off your home, an ARM is likely a gamble you shouldn't make.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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