Buying a home might be the largest single financial investment you ever make. Due to the hefty price tag, you will likely need a mortgage. The interest rate charged on the loan ultimately determines the cost of the mortgage and the size of your monthly payments. Even a small difference in rates greatly affects how much interest you’ll pay over the life of the loan. Take a $250,000 30-year fixed-rate mortgage, for example: At 4.5%, your monthly payment would be $1266.71, and you’d end up paying a total of $206,016 in interest (assuming you stick to the amortization schedule). At 4%, your monthly payment would drop to $1193.54, and you’d pay $179,674 in interest, or $26,342 less than the 4.5% loan.
Because the mortgage rate makes a big difference in how much you’ll pay for your home, it makes financial sense to shop around for the lowest rate you can qualify for.
How To Shop For Good Mortgage Rates
1. Get Your Credit Score.
Lenders will use your credit score to help determine if you qualify for a loan and what rate you’ll be charged. In general, the higher your credit score, the better the mortgage you’ll be offered. It’s a good idea to get a copy of your credit report at least six months before you plan on shopping for a mortgage so you have time to find and fix any errors.
2. Consider Mortgage Types.
Before you shop, determine how much you want to borrow, which type of mortgage you want and how long a term you need so that you can fairly compare lenders. Three basic mortgage types include:
- Fixed-rate mortgage. A fixed-rate mortgage is a conventional loan that has a set rate of interest for the entire loan term, allowing you to spread out the costs of your home purchase over time while making predictable payments each month. Fixed-rate loans are ideal for buyers who have steady sources of predictable income and who intend to own their homes for extended periods of time.
- Adjustable-rate mortgage (ARM). An adjustable-rate mortgage is a conventional loan with an interest rate that changes periodically, usually in relation to an index. The introductory rate (the teaser rate) is often lower than the rate available on a fixed-rate mortgage, but the rate may change at any time after the introductory period, resulting in sometimes sizable increases in your monthly mortgage payment. Be careful with ARMS and make sure you understand how they work
- FHA. Many first-time homebuyers can qualify for FHA loans. These typically have less rigid borrowing requirements with low down payments, reasonable credit expectations and more flexible income requirements. A home financed with FHA loans must be the borrower’s primary residence and must be owner-occupied (no investment or rental properties).
3. Contact Several Lenders.
Mortgage loans are available from several types of lenders – your personal bank, mortgage companies, and credit unions – and you can shop online but I personally recommend sitting down and speaking to someone face to face. I like that personal connection.
Rates fluctuate, and different lenders may offer promotions for certain loan products. You’ll likely receive a different quote from each lender, so you’ll have to shop around to find the best deal. To keep the comparisons fair (apples to apples), provide each lender with the exact same information and make sure you are asking about the same loan: for example, a $250,000 30-year fixed-rate loan with no points.
Remember to compare longer and shorter terms – a 15-year mortgage may have a higher interest rate and monthly payments, but cost significantly less in the long run because you have 15 fewer years of interest payments.
4. Add in the Additional Costs.
The lowest advertised interest rate may not necessarily be the best option since fees can significantly drive up the cost of a mortgage. In general, a mortgage with higher fees will have a lower interest rate, but it’s important to ask about loan origination or underwriting fees, broker fees, and settlement or closing costs. Some fees are paid when you apply for a loan (i.e., the application and appraisal fees), while others are settled at closing. Ask the lender which fees you will be charged and what each fee covers.
Points are fees paid to the lender, and are typically linked to the interest rate: The more points you pay, the lower your interest rate. One point costs 1% of the loan amount and reduces your interest rate by about 0.25%. To find out how much you’ll actually end up paying, ask for points to be quoted as a dollar amount instead of just the number of points. In general, people who plan on living in a home for a long time (10 or more years) should consider points to keep interest rates lower for the life of the loan. Paying a lot of money up front for points may not be worth it if you plan on moving in a shorter amount of time.
Once a lender has made you an offer, you may be able to negotiate for better terms. Ask the lender to write down all the costs associated with the loan – interest rate, fees, points – and then find out if it will waive or reduce any of the fees or offer you a lower interest rate (or fewer points). You can also ask if the lender will offer you better terms than you’ve found elsewhere. Once you are happy, ask for a written lock-in that includes the rate you agreed upon, the period the lock-in lasts and the number of points (if any) to be paid.
The Bottom Line
A mortgage is a long-term financial obligation, and the rate you pay greatly affects the overall cost of buying your new home. A 0.5% difference in interest rates, for example, can save or cost you tens of thousands of dollars over the life of a loan, so it definitely pays to shop around to find the best mortgage rate for which you qualify.