The holiday season is here! Nothing beats spending money on a gift for your spouse, child or friend and seeing their eyes light up. The same can’t be said for spending money on loan interest. Last month, we took a look at four common myths about mortgage interest rates. This month we’re going to talk about some key ways to get a lower interest rate so you can focus more on gifts and less on interest. The three biggest factors lenders use to determine what rate to offer are your credit score, the loan to value (LTV) and the type of mortgage.
Let’s talk credit scores. It’s no secret that your credit score plays an important role in what interest rate you’re offered. Your lender will pull all three of your credit reports/scores to pre-qualify you for a purchase and to eventually lock you at an interest rate. Each credit bureau’s score will be a little different so lenders will use the middle of your three scores. Your credit is only “pulled” with your approval once you agree to move forward. With that in mind, there are some easy ways to ensure your credit is the best it can be. You can prepare for your credit to be pulled by doing things like lowering your balance on a credit card, paying off a monthly credit card like an American Express, or by simply making your monthly payments on time. If you have a high balance because you haven’t yet made your monthly payment, then it’s a good idea to wait to pull the credit score until you have paid.
What most people don’t realize is that your credit score can be improved very quickly. If you’re not happy with your credit score, pay down a credit card balance or make a payment then ask your lender to do a rapid rescore. You’ll be amazed how much of a difference it can make. I’ve seen borrower’s credit scores increase overnight by 10-25 points by simply lowering their credit utilization through these methods. The catch is you have to do it before your rate is locked. Once your rate is locked, there is no going back.
Let’s now move on to the loan to value ratio. LTV is determined by your down payment. For example, if you’re buying a house for $100,000 and you make a $20,000 down payment, your LTV is 80%. In general, loans with a higher LTV carry more risk because Wall Street believes the borrower has less “skin in the game.” Basically, the higher the LTV the higher the interest rate. Typically, you’ll see a lower rate as you cross from 97% to 95%, 90%, 85%, 80%, 75%, 70%, and 60% loan to value. You’ll also lower your private mortgage insurance (PMI) monthly costs as you cross these same levels and eliminate it completely at 80% LTV. Lower or no PMI can significantly reduce your monthly mortgage payment making an increased down payment a win both in interest rate and PMI.
The same does not apply for government-backed loans like a Veterans Administration (VA) or US Department of Agriculture (USDA) loan. They allow 100% financing with no down payment. Since these mortgages are government-backed, little to no down payment does not hurt your interest rate. Plus, PMI is not charged with government backed loans.
Finally, mortgage type greatly effects your interest rate. Some loans are considered riskier than others. Understandably, the higher the risk the higher the rate. Mortgages are originated through your lender and then sold to Government-Sponsored Enterprises (GSE) like Fannie Mae or Freddie Mac. By selling your mortgage, the lender can relend that money to other borrowers. The Enterprises package all of their loans into mortgage-backed securities (MBS) which are then sold on Wall Street to investors. Investors buy the MBS to receive a return on investment based on the perceived risk. Government-backed loans such as VA, USDA, and Federal Housing Administration (FHA) are considered less risky to investors because the Federal Government has an interest if a borrower stops making payments and the mortgage goes into foreclosure. Less risk means a lower interest rate.
The same rule applies to occupancy status. If you’re buying a primary residence you’ll get a lower rate than if you’re buying an investment property to rent out. MBS Investors believe a borrower is more likely to stop making payments on an investment property than their primary residence.
This principle also applies to the loan amount. Jumbo loans (any loan over $453,100) have higher interest rates than conforming loans (loans below the $453,100 threshold). If you’re looking for the lowest rate, you’ll get the best deal on a government-backed, primary residence, conforming mortgage.
Understanding how interest rates are determined will save you a lot of money over the life of a 30-year loan. What I’ve explained here are what I believe to be the three most important factors when I quote a loan for a client. There are more variables in the equation so make sure to ask your loan originator what you could do to get an even better deal. You’ll be surprised how a small change can make a big difference and save you thousands of dollars.
I wish each of you a very happy holiday season and I’m looking forward to a great 2019! Until next year, I invite you to contact me with any questions at jk@mythl.com or on my cell phone at 850-377-1114. I’m always happy to help a fellow pilot navigate the mortgage process.
About the Author: Jonathan Kulak is a licensed mortgage loan originator at Trident Home Loans and an Air Force AC-130 Pilot turned airline pilot. Jonathan is a distinguished graduate of both Texas A&M University and USAF Specialized Undergraduate Pilot Training. He has deployed into combat zones ten times and is a veteran of Operations Iraqi Freedom, New Dawn, Enduring Freedom, Resolute Support, and Inherent Resolve. He holds an FAA Airline Transport Pilot and Certified Flight Instrument Instructor license. Most importantly, he is a devoted husband to his wife Lauren, and the proud father of Vivian, Evelyn, Ruth and Jonathan. Trident Home Loans is a pilot/veteran owned/operated mortgage lender and is licensed in 21 states. For more information visit www.tridenthomeloans.com, call 850-377-1114 or email jk@mythl.com. ACN
