What’s the first thing you think of when you are trying to get a mortgage? You probably worry about the interest rate, right? That’s what most borrowers concern themselves with – they want to know how much the loan is going to cost them.
So how do you get the lowest rate? What determines your rate and do you have any control over it? We look at the factors below.
The FHA Doesn’t Set the Interest Rate
First, you should know that the FHA has nothing to do with the interest rate you receive. The FHA doesn’t fund your loan. The lender that underwrites your loan also funds it. They are ultimately in charge of which interest rate you get. While there are base rates that everyone starts with, the lender has factors that will adjust the loan, one way or the other.
The Risk Factors
Lenders look at your loan application and supporting documents to determine how likely you are to default on your mortgage. The higher the risk, the higher the interest rate a lender will charge you, assuming they approve you for the loan.
The main factors lenders look at include your credit score, LTV, loan term, and the home’s location. We look at how each factor can affect your interest rate below.
You Need Good Credit
It’s not enough to meet the minimum credit score required for your chosen loan program. You want to display great credit to give the lender reassurance that you won’t default on the loan. Oftentimes, the credit score is the first thing lenders see about you, as they pull your credit before they even underwrite your loan. You want your credit score to be one that gives lenders confidence that you can afford the loan and will make your payments on time.
If you have a credit score that is right near the minimum score required, you might get an approval, but it may be at a much higher interest rate. Lenders adjust your rate accordingly. Each lender will adjust for a lower credit score based on their own needs, though, so shopping around can help you get the lowest rate available to you.
You Need a Large Down Payment
The more money you put down on a home, the less risk you pose to the lender. When you invest in your home, you put your own money at risk too. If you default on the loan, the lender will take possession of your home, leaving you with nothing to show for your investment. The more of your own money that you invest, the less risk the lender takes, which means a lower interest rate. Lenders look at it in terms of your loan-to-value ratio. In other words, how does your loan amount compare to the value? The lower your LTV, the lower your interest rate, in most cases.
Borrow the Money for as Short of a Term as Possible
Next, the term that you choose determines your interest rate. The less time you hold onto a lender’s money, the less interest they have to charge you. If you take a 30-year term, like the average borrower does, you will likely get a higher interest rate than the borrower that takes a 15-year term.
If you can’t swing the 15-year payment, but want a lower interest rate, you can consider an ARM, or adjustable rate mortgage. These loans are amortized over 30 years, but they offer a low introductory rate for a fixed period. Once the introductory period ends, you are subject to the market rates plus the predetermined markup, though. You can use the ARM to give you time to increase your credit score or fix other factors that affect the rate you get. Once you are ready, you can then refinance and hopefully get the smaller interest rate.
A Factor You Can’t Control
The final factor is the location of the home. Some areas are deemed as ‘risky,’ and will force lenders to give you a higher interest rate. You can talk to various lenders about the interest rates in your area and see which one will give you the lowest rate. You can also maximize your other factors to make the lender feel that you are a good risk and want to give you as low of a rate as possible.
Your interest rate has nothing to do with the FHA even though you take out an FHA loan. It comes down to the lender and you. What qualifying factors do you bring to the table? That’s what will determine the rate that you get.