Why that great mortgage rate offer might not apply to you
It can be one of the most frustrating and disappointing parts of the mortgage application process: You see what looks like a fantastic low interest rate advertised online, or on a sign. Then you go into the bank offering the rate only to find out that you don't qualify. So, what happened?
The reality is that many factors go into the equation. Macroeconomic inputs ranging from monetary policy to the state of the bond and housing markets can shift rates in real time — it's not uncommon for rates to change over the course of a day, sometimes more than once. And every borrower's personal financial situation, employment status and credit score will also affect the interest rate offered by a lender.
In addition, different types of mortgages will yield a variety of rates. For example, a fixed-rate loan guarantees that the interest rate remains the same for the entire term of the mortgage. A variable-rate mortgage, on the other hand, can fluctuate based on a benchmark interest rate.
You will also see the term "annual percentage rate," or APR, when shopping for a mortgage. The APR is a broader measure of what it costs to borrow this money. In general, the APR reflects not only your interest rate but also any points, mortgage broker fees, and other charges that you will pay to get the loan. For these reasons, the APR for a mortgage loan can be higher than the advertised interest rate. (More information on points later.)
One way to qualify for a lower interest rate is to consider an adjustable-rate mortgage. These loans have low introductory interest rates that last for a designated length of time before changing. For example, a 5/1 adjustable-rate mortgage will carry a fixed rate for the first five years. After five years the interest rate will then vary based on certain benchmarks.
Adjustable-rate mortgages be risky because after the introductory period, the rate can change every year over the course of the mortgage. For example, if you have a 5/1 adjustable-rate on a 30-year mortgage, you will always have a monthly payment based on the 30-year loan. But your interest rate is only protected for the first five years. So, starting with year six, that rate can adjust annually by the lender.
ARMs can work well for borrowers in situations where they know they will not be in their home after the fixed-rate period ends. For example, consumers comparing a 30-year fixed loan versus a 10-year ARM might find the adjustable rate is a much better deal if they are certain they will be moving and not remain in this particular home in 10 years.
If you know that you will be buying a home and looking for a mortgage soon, now is the time to try to improve your credit score. Again, the lowest rates advertised by banks and other lenders usually only apply to borrowers with the best credit profiles who can meet other requirements, like a specific down payment. You can try to negotiate interest rate with your mortgage broker, but only very well-qualified borrowers will have any negotiating power.
Borrowers can also use prepaid interest points to negotiate a lower mortgage rate from their lenders. Points allow you to make a tradeoff between your upfront costs and your monthly payment. By paying points, you pay more upfront but receive a lower interest rate and pay less over the full period of the loan. Buying points can be a smart choice for consumers who know they will stay in their homes and keep their mortgages for a long time.
Points are calculated in relation to the full loan, with each point equaling one percent of the total amount of money borrowed. For example, one point on a $100,000 mortgage would equal 1% of the loan amount, or $1,000. Two points would be 2% of the loan amount, or $2,000.
Another way to qualify for a lower interest rate is to put down an ample down payment on the loan — 20% of the purchase price is still the industry standard. The bigger your down payment, the more equity you will have in your home and the lower your mortgage rate will likely be. Finally, always compare mortgage interest rates from more than one bank. Buying a home is the biggest purchase most consumers will ever make, so it's important to shop around and compare offers from multiple lenders.