Getting the Lowest Rate on Your Home Loan

Every home buyer wants to get the lowest possible rate on a mortgage loan. It can reduce the size of your monthly payment and save you thousands of dollars on your total interest costs. Who doesn't want that?

But many first-time buyers don't understand how mortgage rates are assigned in the first place, or what it takes to get the lowest rate on a home loan. So that's what we are going to discuss in today's lesson.

A Lower Mortgage Rate Could Save You Thousands

If I asked you why it was so important to get a low interest rate on your mortgage, you would probably say that it lowers your monthly payment. This is true. But let's think long-term for a moment. Many people don't realize how much money they can save over time by securing a lower mortgage rate.

Consider the following:

Here are two different home-loan scenarios where everything is the same except for the interest rate. I've taken these numbers and plugged them into a mortgage calculator to determine two things: How much will the monthly payment be? And how much interest will be paid overtime?

Home loan scenario #1

• The borrower takes out a 30-year fixed-rate mortgage loan.
• The loan amount is $250,000.
• The borrower gets approved for an interest rate of 6.9 percent.
• The monthly payment will be approximately $1,646.
• The total interest paid over the term of the loan is $342,740.

Home loan scenario #2

• Again, the borrower is using a 30-year fixed loan.
• The loan amount is the same as the first scenario -- $250,000.
• This time, the borrower gets approved for a mortgage rate of 5.4 percent.
• This is about the lowest rate for a mortgage in the current market.
• The monthly payment will be approximately $1,400.
• Total interest paid over the life of the loan is $255,377.

This is a realistic scenario that highlights the benefits of getting the lowest rate on a home loan. With all other things being equal, a lower mortgage rate can save you thousands of dollars over time. It also reduces the size of your monthly payment, which is beneficial in the short term.

Take a look at the numbers in the two scenarios above. In the second scenario, the borrower is paying about $246 less every month. He's also paying about $90,000 less in total interest over the life of the loan. Granted, most people move or refinance well before the 30-year mark. But there's still a huge potential for savings if you can qualify for the lower rate.

"Lowest" Can Mean Two Different Things

A distinction needs to be made at this point. When we talk about getting the "lowest rates" on a home loan, it can actually mean two different things:

• We might be talking about getting the lowest interest rates available in the current mortgage market. This is the top tier, and it's harder to reach.
• Or, we might be talking about getting the lowest rates possible, based on your qualifications. This is the second tier.

These are two different things entirely. Here's the difference...

Let's say the average mortgage rate at a particular time is around 5.5 percent. Borrowers with excellent credit and larger down payments will qualify for even better rates. Let's say the lowest rate available is 5.25 percent. In order to qualify for this rate, however, you would need to have excellent qualifications as a borrower. In other words, it will only be offered to a select minority of borrowers.

Let's further assume that my credit score is merely average, and my debt ratios are fairly high. Under these circumstances, the lowest rate I can get a home loan might be closer to 5.7 percent. Therein lies the distinction.

This is why you need to be realistic as a borrower. If your credit score is only average (or below), you shouldn't expect the lender to offer you their best rates. The same goes for your down payment, your debt-to-income ratio, and other qualifying factors. You must perform well in all of these areas to qualify for the lender's lowest interest rates.

Why am I telling you all this? Because I don't want you to go into the process with false expectations. Average borrowers can qualify for average rates. Borrowers with stronger qualifications can generally qualify for the best rates available. And those with shaky credit or other financial problems may not qualify for a mortgage at all. It has more to do with your individual qualifications as a borrower than anything else.

How to Qualify for the Best Rates

So let's say you're determined to get the lowest rate on a home loan. You're motivated, you're disciplined, and you're ready to do whatever it takes to qualify for the best rate. Where do you begin?

When you apply for a mortgage loan, the lender will review many aspects of your financial situation. But there are three factors in particular that will help your cause more than anything else. If you want to qualify for the lowest possible mortgage rate, you need to focus on these three things:

• Your credit score. If you want the lender to offer you their best rates, you're probably going to need a credit score of 740 or higher. This is your FICO score by the way, which is the one used by most lenders. You can improve your score by paying your bills on time, lowering your credit card balances, and protecting the length of your credit history. Learn more here
• Your down payment. With all other things being equal, a larger down payment will help you qualify for a lower interest rate on the home loan. You also have the added benefit of equity. This is why I recommend making a down payment of at least 10 percent, if possible. Learn more here
• Your debt ratio. During the mortgage application process, you will probably hear the term "debt-to-income ratio" used a lot. This is a numerical comparison between the amount of money you earn, and the amount you spend on your various debts. For example, if you spend about a third of your income to cover your monthly debts, then your debt-to-income ratio is around 33 percent. A lower ratio will help you qualify for the lowest rates on home loan. Learn more here

These aren't the only things the lender will look at when you apply for a loan. But they are some of the most important factors. If you're strong in these three areas, there's a good chance you will be offered the best rate available.

Before Shopping for a Home Loan

In closing, I'd like to talk about some of the things you should do before applying for a mortgage. If you do the research recommended below, you'll be much better prepared for the process. This will also help you spot the lender with the best deal.

1. Monitor the average rates.

You won't know if you're getting the lowest rate a home loan unless you know what the current trends are. Fortunately, this information is very easy to find. Freddie Mac conducts a weekly survey of the primary mortgage market to determine what the average interest rates are. It gets updated every week. I recommend keeping track of this data.

2. Know your credit score.

You wouldn't play poker with your cards facing your opponents.  Nor would you want to negotiate with a lender who knows more about your finances than you do. Before applying for a mortgage loan, you need to know where you stand in terms of your credit and debt. You can check your credit score online through MyFICO.com. You can estimate your debt-to-income ratios simply by using a calculator.

3. Establish a budget.

This has more to do with your own financial well-being than anything else. But I wanted to include it here because it's such a good practice. Before you apply for a home loan, you should have a certain number in mind. This number is the maximum amount you're comfortable spending each month toward a mortgage payment. That way, if you get approved for a larger amount, a red flag will go up in your head. Learn more here

This article explains how to get the lowest rates on home loan in 2011. If you would like to learn more about the subject, you can use the search tool at the top of this page. It allows you to search a library of more than 1,000 articles. Most of these articles relate to mortgages in some way. So you're bound to find the information you need. Good luck with your home-buying process.