Although record-low interest rates are in the rear-view mirror, and rates have been steadily creeping up, they’re still relatively low (remember the 18% average in 1983, or even the 5.8% average for a 30-year fixed-rate loan in 2009?). It’s still a good time to buy if you’re looking to purchase your first home, trade up, downsize—or refinance your current home to lock in a better rate.
The tips below can help you understand how easily you may be able to get a loan with a good rate, what your down payment and monthly expenses may be, and whether now is a good time for you to act.
Assess your mortgage fitness
While loans are more available than they have been, that doesn’t mean just anyone can get one. Ask yourself these questions to assess your chances:
- Am I a good credit risk? One of the first things lenders do is pull your credit score. The most common is the FICO score, which is based on data from one of the three major credit bureaus (Equifax, Experian and TransUnion). Lenders typically use the lower of two scores, the middle of three or the average of all scores. If you have a co-borrower, they usually compare your scores and use the lower of the two or average them. Mortgages backed by the Federal Housing Administration require an average score of 690 out of 850, according to the Ellie Mae Origination Insight Report, which analyzes mortgage loan applications. But many lenders will allow a larger down payment to offset a lower credit score.
- Do I make enough money? Lenders look at the ratio of your monthly housing expenses to your income. Monthly housing expenses include loan principal and interest, real estate taxes, hazard insurance, plus mortgage insurance if you have to pay it, and any condo or association fees. In general, housing expenses shouldn’t exceed 25% to 28% of your gross monthly income.
- Can I handle the extra debt? If you have a lot of debt, you may not qualify. To measure your “capacity,” or your ability to take on more debt, a lender will look at your income history and that of your spouse, your debt-to-income ratio by totaling all your credit card and other debt payments as a percentage of your income, and the amount of savings you have. If you have a lot of debt—more than 45% of total debt to income—you’ll have to have a stellar credit rating and put a lot of money down to get a decent loan rate.
- Do I have to pay PMI? Those initials mean private mortgage insurance, and homeowners hate them! If your down payment is less than 20%, you may have to pay PMI, which protects the lender if you quit paying your loan. The more you put down and the higher your credit score, the less PMI you’ll pay. Note that when the principal balance of your loan falls below 80 percent of your home’s original value, you can ask your lender to cancel PMI. Just be aware you may have to pay for a new appraisal.
- Do I qualify for any special loan programs? For example, you may not need a down payment or mortgage insurance if you (or a co-borrower) qualify for a Veterans Affairs home loan. You will, however, have to pay an up-front fee of up to 3.3 percent of the loan amount. In addition,Single Family Housing Loans from the U.S. Department of Agriculture allow qualified, low-income borrowers in selected areas to buy with nothing down, although they also will pay an up-front fee and an annual fee.
Judge your refi readiness
Be sure that refinancing to a lower interest rate—and maybe a lower monthly payment—will actually save you money. Ask yourself:
- How low can I go? Get loan estimates from several lenders to check rates and see how much you’d pay in closing costs. Forget the rule of thumb that to refinance your mortgage you need to reduce your rate by two percentage points. The question is whether you will stay in your home long enough to recoup the closing costs with savings on your monthly payments.
- How long will it take to break even? For a rough idea, simply subtract the new monthly payment from your current one and divide that into the total closing costs. You can also use this calculator to get a general idea of whether you’re better off if you refinance.
Taking the plunge
Before you take out a new mortgage or refinance an existing loan, there’s one more important question to ask:
- Have I shopped around enough? The Consumer Financial Protection Bureau, the federal government’s new agency to protect consumers, says that 77% of borrowers apply to only one lender. However, the Bureau recommends asking for loan estimates from at least three and comparing the deals. Check out CFPB’s new interactive website for more information.
You’ll also want to consider if you should pay more “points” on your mortgage to get the lowest interest rate. You have to decide which is more important to you: paying cash up front for a lower rate or keeping more cash in your pocket for a slightly higher monthly payment.
Ultimately, getting a new mortgage or refinancing one can seem complicated. But if you do a little homework, it should be relatively easy. Spring is a top time for real estate sales, and even though interest rates are rising a bit, they are still much cheaper than in the past. It’s definitely not too late to take action.