There are numerous factors considered when you are quoted an interest rate for a mortgage – whether a purchase or refinance. One good factor, such as an excellent credit rating does not automatically win you the lowest interest rate available nor does putting more than 20 percent down on the home. It is a combined effort between all factors of your mortgage application which determine the rate which you are offered by a mortgage lender. The best way to ensure a low rate is to paint the entire picture for a mortgage lender one that shows responsibility and consistency.
The Credit Score Factor
Your credit score is one of the largest factors determining your interest rate, but it does not work alone. Before you apply for a mortgage, it is important to ensure your credit rating is in good standing. There are various levels of the credit scoring; each lender will have their own threshold when it comes to determining excellent, good, fair and poor credit, but in general, this is what they look for:
- Excellent – Any credit score over 720 is considered excellent
- Good – Credit scores between 690 and 720 are considered good
- Fair – Credit scores between 630 and 689 are considered fair
- Poor – Any score lower than 630 is considered poor
The ranking of your credit score is one level used in determining your interest rate. Excellent credit rating means you use your credit responsibly, pay your bills on time and are not overextended on any of your accounts. As you move your way down the credit ranking table, your credit history becomes blemished, your credit score goes down and so does your ability to have one of the lowest interest rates available.
The Down Payment Factor
The amount of down payment you put down on a home also plays a role in your interest rate. If you are refinancing, the total loan-to-value ratio of your loan is what will matter. The higher your LTV, the less likely it is you will obtain a low interest rate. The amount of equity you have in your home determines a large portion of the risk factor of your loan. The more the bank has to loan you, the riskier your mortgage becomes.
For instance, a borrower with a 95% LTV only holds 5% equity in his home. On a home worth $250,000, this amounts to $12,500 while owing the bank $237,500. That $12,500 is a small chunk of change in the grand scheme of things. In comparison, a borrower with a 75% LTV with the same home value holds 25% equity in his home, which amounts to $62,500 and only owing the bank $175,000. The borrower with the higher amount of equity is more likely to find ways to keep his home, avoiding the risk of default, than the borrower with less equity. The bottom line to take away from this is to put down as close to 20 percent of the purchase price as possible in order to keep your interest rate down
Determining your Final Interest Rate
Now it is time to put it all together. The lender will look at your credit score and down payment or LTV separately and together. Each factor plays a role in the rate you are offered, but they work collectively to determine the final outcome. Let’s look at an example:
- Borrower 1 – This borrower has a fair credit score (675), but puts down 25% of the purchase price from his own funds. The credit score will hit his interest rate a bit because it is not excellent or even good, but the LTV of the loan will act favorably, providing him with a compensating factor, allowing the interest rate to go down a little further than someone with fair credit and a high LTV.
- Borrower 2 – This borrower has an excellent credit score (790) but puts down only 5% on the purchase of his home. His credit score will allow him some of the lowest interest rates, but he will take a hit on the very high LTV, pushing the interest rate up a little more.
As you can see, the perfect scenario would be an excellent credit rating combined with a sizeable down payment. In many instances this perfect scenario is not an option, but getting as close as you can to both sides can help you to obtain the lowest interest rate for your new loan.Click to See the Latest Mortgage Rates»