If you’re currently shopping for a mortgage, you are probably asking yourself why you waited so long. For the last 15 years, interest rates, particularly mortgage rates, have been at all-time lows. In the pandemic era of 2020 and 2021, mortgage rates actually fell below 3% for the first time in history, with rates rarely rising above 5% in the foreseeable past. As you are well aware, if you are looking, things have changed.
On the bright side, rates are nowhere near all-time highs that were hit in the early 80s, as the following chart shows.
Refinancing a current mortgage has come to a standstill since rates have risen, leaving new underwriting as the main driver in the current real estate market. Anyone who was able to refinance during that 2020/2021 period of ultra-low rates, and are generally staying put in their current residence, unwilling or unable to move based on today’s higher rates. This is one dynamic that has held property values high. With little movement, supply is scarce, increasing prices despite rising interest rates.
In case you are wondering if it is worth the time and effort to shop rates, even the slightest reduction in a mortgage rate will save you a ton over the life of the loan. Take a look at the difference that incremental rate changes can make on the cost of a 30-year, $400,000 home loan below:
As you’re probably aware, your loan is amortized over a term period, usually 30 years. With these loans, you’ll pay more interest upfront and less toward the end of the term. For example, your first payment at 6% would see $2,000 go toward interest, while your final payment would have just $11.93.
Let’s take a look at the macroeconomic factors that affect mortgage rates before drilling down to your own personal finances. While the Federal Reserve is front and center of interest rate news, it is just one component of how mortgages are priced.
There is typically an inverse relationship between the strength of the economy and rates. When the economy is strong, rates tend to be higher, and as the economy slows rates generally drop. According to Bill Banfield, an executive at lender Rocket Mortgage, “Interest rates often will rise or fall based on the strength of the economy, and ironically, bad news can be good news for lower interest rates.”
It’s understandable that the process can seem daunting. Most people don’t like math, and with sixty percent of America living paycheck to paycheck, just getting a loan would make most happy. The number of lenders out there is enormous as well. The U.S. has more than 4,300 mortgage lenders, ranging from small credit unions to online startups to national banks. Picking the wrong lender can sometimes mean not qualifying for a mortgage at all.
Before you start shopping around take an assessment of your household’s financial condition. The best mortgage rates are typically reserved for borrowers with the best credit scores, so you’ll want to know where your credit score will stand with lenders. According to Nerdwallet, Scores in the highest range (720-850) are considered “excellent,” while scores in the 690-719 range are “good,” scores in the 630-689 range are “fair,” and scores in the 300-629 range are “bad.”
The three main credit rating agencies are Experian, Equifax, and TransUnion. You can get complimentary credit reports by visiting AnnualCreditReport.com, the only authorized source for obtaining them from the three major credit reporting bureaus.
In addition to your credit profile, income and expenses are probably the most important component involved in getting a good rate. Lenders will also consider your debt-to-income ratio (DTI). This is the percentage of your gross monthly income for paying your debts. This number does not include non-debt expenses, such as groceries or utilities. Lenders typically want this number to be no higher than 36%. The lower, the better.
It’s important to consider several lenders before choosing where to get your loan. Freddie Mac recommends getting at least four quotes (apparently, it could save you an average of $1,200 a year). Just make sure you’re not only going by the rates a lender advertises on their website or on third-party sites. One way to avoid this is to get pre-approval for a home loan from a lender.
Getting pre-approved for a mortgage can give you a sense of what kind of rates lenders are willing to offer you. It also strengthens your position when negotiating with sellers. Applying for preapproval with a few lenders gives you an opportunity to compare offers and see who is offering the lowest rate.
Lastly, even in what seems to be a lender market, have mortgage companies compete for your business. Remember, mortgage rates aren’t set in stone and lenders still need to lend to be profitable. So don’t hesitate to negotiate with lenders to get a better rate.