When youâre shopping for an affordable place to live, a homeâs list price is the first thing most people consider. The median sales price of homes sold across the U.S. is $307,700 according to data from the U.S. Census Bureau and the Department of Housing and Urban Development.
But thereâs a lot more that goes into your monthly payment. Equally important is the interest rate you get on your mortgage. And just as you shop for a home, you can shop for the best rate on a mortgage.
How can you get the best rate? Youâll want to improve your credit score, pay down debt and contribute as large of a down payment as possible, but youâll also want to shop around to ensure you receive a competitive mortgage rate.
The interest rate on your loan can make or break whether that mortgage will be affordable. Letâs look at an example, using LendingTreeâs mortgage payment calculator.
Weâre assuming a 30-year fixed-rate mortgage on a $200,000 home with 20% down, or a $40,000 down payment. The mortgage payment amounts also include homeowners insurance ($700 per year) and property taxes ($2,500 per year). The taxes and insurance amounts are each divided by 12 and added to the mortgage payments.
4.00% Interest Rate
4.50% Interest Rate
5.00% Interest Rate
Total loan amount
Monthly mortgage payment
Total interest amount
A half-percent increase in your mortgage rate could cost you nearly $50 more on your monthly mortgage payment, and close to $17,000 in interest over the life of your loan, while a full-percent difference in your mortgage rate comes with a monthly payment that is $95 higher and a loan that costs another $34,000-plus in interest over a 30-year term.
Before you can shop for a mortgage, itâs important to understand the data points that go into the rates that lenders offer you.
Lenders previously relied on a rate sheet when quoting mortgage rates to prospective mortgage borrowers, but now thatâs all done online, said John Stearns, a senior mortgage banker with American Fidelity Mortgage Services in Milwaukee. Today, loan officers log into a pricing system and input the borrowerâs credit score, loan amount and ZIP code to provide a rate quote.
There are several factors, including the details mentioned above, within your control, giving you the power to help influence the rate you receive.
In short: The better your credit scores, the better your rate will be. Improving your credit score is one of the most effective ways to influence your mortgage interest rate. In fact, taking the time to increase your score could mean the difference of more than a full percentage point. Your credit score is arguably the most important factor influencing your rate, said Stearns.
When lenders pull your credit scores from each of the three credit reporting bureaus â Equifax, Experian and TransUnion â they use the middle score of the three to help determine your estimated mortgage rate. Thatâs why itâs important to ensure youâre improving and maintaining a good credit profile across all three bureaus.
There are minimum required credit scores for several mortgage programs. For example, conventional lenders want to see at least a 620 score and in some cases 640. FHA lenders want to see a 580 score if youâre planning to make the smallest down payment possible, which is 3.5%.
Still, skating by with the absolute minimum score wonât get you the best mortgage rate available. A lower score means a higher mortgage rate, so youâll potentially save thousands by striving toward a good or excellent credit score. If you want a chance at the lowest mortgage rate possible, ask each lender you gather quotes from what score youâll need to get the best rate.
âThe breaking point for me is 740,â Stearns said, referring to the score cutoff after which mortgage rates donât go any lower. âAfter that, it doesnât matter.â
The more money you put down toward your home purchase, the lower your interest rate will typically be. If youâre applying for a conventional mortgage, have good credit and plan to put down at least 5%, youâll likely qualify for a more competitive rate. There are some conventional loan programs that allow 3% down, but they sometimes come with income limits and homebuyer education requirements.
Donât confuse a lower interest rate with a lower cost of financing, however.
Most conventional lenders require you to pay for private mortgage insurance (PMI) if you donât contribute at least a 20% down payment. PMI adds about 0.5% to 1% of your loan amount per year to your mortgage payment and canât be removed until youâve built up at least 20% equity in your home. You build equity when your home value increases and you pay down your mortgage balance.
If youâre putting down less than 5%, a FHA loan or VA loan might work better for you. FHA loans require a 3.5% down payment, as well as upfront and annual mortgage insurance premiums (MIP). The upfront MIP is 1.75% of the loan amount. Annual mortgage insurance premiums are divided into 12 installments and paid monthly as part of the mortgage payment. The cost ranges from 0.45% to 1.05%, depending on your loan amount, loan-to-value ratio and loan term. In most cases, you canât get rid of MIP unless you refinance into a conventional loan.
VA loans are reserved for military personnel and veterans and have competitive rates for people who donât have a down payment. There is a mandatory upfront financing fee, however. Check the VA loan fee schedule to see if the financing fee is worth it to you.
Interest rates on smaller mortgages tend to be higher than rates on typical mortgage sizes because they are less profitable. Borrowers may need to work with local banks or credit unions or government lending programs to find a smaller loan.
Letâs say you wanted to take out a small mortgage of less than $50,000 to purchase a fixer-upper house. That lower loan amount will likely have a pricey mortgage rate.
You might see a lower mortgage rate on a higher loan amount, however.
âBanks may say, âWow, youâre borrowing $300,000, Iâll give you a little deal on the interest rate,ââ Stearns said.
At the other end of the spectrum are jumbo mortgages, or loans that donât follow conforming loan limits. Banks canât sell jumbo loans in the secondary market, so they are riskier for the bank compared to other mortgages. Usually, banks compensate for higher risk with higher interest rates, but rates on jumbo loans have been trending lower than conventional loans as of late.
Where youâre buying a house matters â mortgage rates vary from state to state and can even differ within certain areas of a given state.
Buyers looking for a mortgage in a rural area may see higher rates compared to equally qualified buyers in nearby urban areas, which could be attributed to less competition or unfamiliarity with the region. Some larger lenders have less familiarity with lending in rural areas, which could lead to higher rates. In rural settings, you may get the best rates from local banks and credit unions.
States with laws in place that make foreclosure difficult tend to have higher mortgage rates than states with looser foreclosure laws. Likewise, states that require lenders to have a physical presence in the state also raises interest rates.
Mortgages with shorter terms typically have lower rates than those with longer terms. Banks consider longer-term loans to be more risky and compensate for the risk by charging higher rates.
The average 15-year fixed-rate mortgage is 3.57%, according to Freddie Macâs latest Primary Mortgage Market Survey. By contrast, the average rate for a 30-year fixed-rate mortgage is 4.1%.
This doesnât necessarily mean that a shorter-term loan is always the right choice. Choose the term that fits your needs before you compare rates. That way youâll get the best interest rate on the right mortgage for you.
The loan program you choose may not seem as important as the other factors referenced, but it does have an influence on your rate. Conventional loans tend to have the lowest interest rates. This refers to mortgages that can be purchased by government-sponsored enterprises Fannie Mae and Freddie Mac, the largest purchasers of mortgage loans in the U.S.
As previously mentioned, conventional loans require good credit and at least a 5% down payment in most cases, though there are some loans that allow 3% down. Youâll need to put at least 20% down to avoid paying PMI. Lenders can easily sell these loans to Fannie Mae or Freddie Mac and reinvest the proceeds in making more loans.
FHA loans have more lenient down payment and credit standards, and their average interest rates have been typically less expensive than those of conventional loans. But as of late, FHA loans have had the higher interest rates. However, an FHA loan may be the right option if you only have access to a small down payment and have a lower credit score. The extra costs of the annual and upfront mortgage insurance premiums are other factors to consider when deciding whether an FHA loan is right for you.
VA loans are available to military servicemembers and veterans, and they charge an upfront fee. However, they offer competitive rates for homebuyers.
If youâre taking out a jumbo mortgage, you will likely need to qualify for conventional underwriting. Likewise, condo buyers may need to qualify for a conventional loan. Keep in mind that Fannie Mae and Freddie Mac will not purchase a mortgage if the property is part of an association that has more than 50% renter occupants.
Adjustable-rate mortgages put more risk onto borrowers. Youâll initially pay a lower interest rate if you take out an adjustable-rate mortgage, but the rate could increase down the line when your loan enters its adjustment period. By contrast, fixed-rate mortgages donât increase or decrease over the life of your loan.
If youâre considering an adjustable-rate mortgage, learn when and how the interest rate adjusts. Most loans adjust based on a set index. In a low-interest-rate environment, you can expect rates to increase, but you need to estimate how much. Weigh whether the low rates now are worth a potential high rate in the future.
Many lenders offer what are called âdiscount points,â or money the borrower can pay to lower their mortgage interest rate. One discount point is generally equal to 1% of the loan amount. So, if youâre borrowing a $200,000 loan, one point would cost you $2,000.
In some circumstances, buying discount points makes sense. Dividing the cost of the point by the change in your monthly payment will tell you the number of months it takes for the discount points to pay off in terms of savings. If you have the cash and expect to stay in the house significantly longer than the payoff period, purchasing the points could be worthwhile. Otherwise, keep the higher interest rate.
Cities and states often offer special interest rates on loans for homebuyers who meet certain criteria. For example, the Georgia Dream Homeownership Program offers a 4.375% interest rate on 30-year fixed-rate mortgages for eligible homebuyers â plus down payment assistance for some borrowers. In many cases, this is a lower rate than the same borrower would qualify for elsewhere.
Check your city, county and state housing finance websites to see if you qualify for special rate programs. They often have favorable borrowing terms in addition to great rates.
There are also factors you canât control, such as the movement of the 10-year Treasury bond yield, inflation and the Federal Reserveâs monetary policy decisions, that can impact mortgage rates.
When it comes to buying a house, you donât just need to house hunt; you need to shop for a mortgage. Homebuyers could potentially save more than $37,000 in interest over the life of a 30-year fixed-rate $300,000 loan by comparison shopping, according to research from LendingTree, MagnifyMoneyâs parent company.
Your mortgage rate can make or break the affordability of a house, and itâs up to you to find the best one. These are the steps you can take to shop around.
Even before shopping for a mortgage, make sure to pay your bills on time and keep your credit usage low. Try to use less than 30% of your total available credit, like your limit on a credit card. Once youâve started shopping, donât close old credit accounts or apply for new accounts while youâre in the middle of the process.
Additionally, review each of your credit reports for errors and have any inaccurate information removed or corrected.
For more help with improving your creditworthiness, consider these tips for rebuilding your credit score.
Along with improving your credit score, lenders want to see how well youâre managing your current debt load. If youâre maxing out credit cards and taking out loans left and right, thatâs not likely to work in your favor when applying for a mortgage.
One of the most important factors that lenders consider is your debt-to-income ratio, or the percentage of your gross monthly income that is dedicated to debt payments. Most of the time, lenders will not extend mortgages to borrowers whose monthly debt liabilities eat up more than 43% of their income.
The Consumer Financial Protection Bureau offers a tool that allows you to compare the interest rates in your state for various types of loans. Another option is to use a rates comparison tool, such as the one offered on LendingTreeâs website. This will give you an idea of the ballpark your interest rate quote should be in.
To use these tools, you need to know your credit score, the amount you intend to borrow, down payment amount, loan term and loan type. By exploring the different options, youâll get an idea of the rate landscape in your state.
After youâve found the mortgage lenders with the best rates, consider applying for a mortgage preapproval. A preapproval is a letter you receive from a lender that gives you an estimated loan amount and interest rate, based on a review of your financial information including bank statements, credit reports, pay stubs and tax returns. Preapprovals are conditional and often last for about 90 days.
You can compare your preapproval offers to see which lender is offering the best combination of rates and fees. Ask for a worksheet that outlines your estimated fees once you have your preapproval.
A preapproval isnât subject to full underwriting or an appraisal. Rates can change after you get a preapproval, though in some cases you can lock an in interest rate at this point.
Your preapproval letter has the added benefit of giving you something legitimate to submit with an offer on a home. Home sellers like to see preapprovals because it means youâre likely to have access to the financing to close a deal.
Once youâve been preapproved, you can start shopping for houses, submitting bids and negotiating home prices.
Once a home seller has accepted your offer and youâve also chosen your mortgage lender, itâs time to speak with that lender about your mortgage rate lock options.
A mortgage rate lock is a feature lenders offer during the homebuying process that allows you to lock in your mortgage rate for a predetermined time period. When you have a rate lock in place, your mortgage rate wonât change from the date the lock takes effect until your closing date, with the caveat that you actually close on your mortgage before the rate lock expires.
Some common rate lock terms include 30, 45 or 60 days. If your mortgage doesnât close in time, then youâll need to purchase a rate lock extension, which could cost up to 0.50% of your loan amount.
Finding a great rate on a loan that you canât pay back is a sure way to destroy your credit. Before you apply for a loan, establish a realistic budget for your monthly mortgage payment and avoid borrowing more than you can comfortably afford to repay.
No matter how large a loan you can qualify for, you need to be a savvy consumer. Keep your monthly mortgage payment (principal, interest, taxes and insurance) at or below 30% of your gross monthly income.
Before you start shopping for houses, determine how a mortgage will fit into your budget. Donât succumb to pressures to overextend yourself. A burdensome mortgage has the power to turn a dream house into a nightmare. You can avoid the nightmare by planning ahead.
Youâll also need to determine your non-mortgage-related recurring costs before committing to a new loan. Calculate income taxes, transportation and child care or education costs. If you pay alimony or for out-of-pocket health care, consider those costs as well. Additionally, factor in the costs of home maintenance. Experts recommend setting aside 1% to 3% of your homeâs purchase price annually for maintenance and upgrades.
In addition to establishing a budget, you need to understand how to find the right features on a mortgage. A great rate on a bad mortgage could spell financial ruin. When youâre shopping for loans, ask yourself these questions:
Some buyers purchase houses with the intention of staying just a few years. Someone who plans to sell in a few years might consider an adjustable-rate mortgage rather than a fixed rate, since interest rates are typically lower in the first few years. However, an adjustable-rate mortgage is risky for someone who intends to live in a home long term.
How stable is your income? What about your savings? If you have access to a hefty amount of savings, consider making a larger down payment and choosing a 15-year mortgage over a 30-year mortgage to borrow less and grab a lower interest rate.
People with a moderate income and little savings might feel more comfortable with a smaller down payment and a longer payoff period. This will mean paying mortgage insurance and higher financing costs, but they can be worth it for peace of mind.
An advertised interest rate doesnât account for your total cost to borrow money. Most banks make their real money by charging closing costs. These include loan origination fees, recording fees, title inspection fees, underwriting fees and application fees.
All the financing charges will be disclosed on your Loan Estimate. The document will also provide you with an annual percentage rate (APR), which expresses the total cost of borrowing money, including the financing fees.
Closing costs can range from 2% to 5% of a homeâs purchase price, and in some cases can be rolled into the loan. Check with your lender for more information about payment options.
Some borrowers cut their total interest costs by accelerating their mortgage payoff. If you have room in your budget to tackle your mortgage debt more quickly than expected, you can save money in the long run.
Making biweekly mortgage payments works out to an extra mortgage payment every year. This cuts a 30-year mortgage down by more than four years, and can shorten your loan term even more if you frequently pay more than expected.
If you have a conventional loan, making extra payments can help you achieve 20% equity faster, which will allow you to drop PMI payments. For FHA borrowers, building your equity at a faster pace means you can possibly refinance into a conventional loan and drop your mortgage insurance premiums, provided you have a 80% LTV ratio or lower.
Sometimes the most difficult part about shopping for a mortgage is understanding the terms that lenders use. Below weâve defined a few of the most common mortgage terms that you should know before you commit to a loan.
This article contains links to LendingTree, our parent company.