Since lenders use tiered pricing, getting a low mortgage rate depends on several factors. The borrower’s credit score plays a large part, but banks will also consider employment, income, debt, cash reserves and the size of the down payment.
The FICO credit score not only qualifies you for a mortgage, but it also determines the financing rate. Higher credit scores garner lower mortgage rates, unless the other factors have significant positive differences. The best mortgage rates apply to borrowers who score above 760. While exceptions exist, you generally need to score at least 620 to obtain a mortgage.
Income and Employment
Mortgage lenders like to evaluate income stability. Ideally, this means at least two years of employment for the same company, or a job change that came with higher pay in that time period. Self-employment requires income tax returns and IRS form-4506.
To set mortgage rates, lenders consider two debt-to-income ratios: back end and front end. The former measures all minimum debt payments and the new housing cost, divided by the regular gross salary. The latter just considers the housing budget.
Traditionally, borrowers should have ratios of no more than 36 and 28 percent for these types of debts. In a nutshell, this means that housing costs should not exceed 28 percent of the income. If a borrower has strong overall finances, lenders will allow higher debt ratios.
Cash reserves include certificates of deposit, money market funds, checking account and savings account funds. Lenders look for at least enough money to cover two months of mortgage payments. Funds in retirement plans don’t count because their withdrawal incurs penalties and taxes.
Since a higher down payment reduces the risk factor, it will also lower the interest rate. Generally, lenders expect 20 percent down to get the best rate. You can get a mortgage when just paying 5 percent down, but it will come with a higher interest rate.
While these five crucial factors determine the mortgage rate essentials, results can fluctuate slightly from lender to lender. That’s because each bank has teams of underwriters who evaluate each item on the credit report. While many people have the same credit score, the path of how they got there varies from person to person.