Have you been thinking of buying a home or refinancing your mortgage, but wonder what it will take to qualify for those great mortgage interest rates you've heard touted in the press?
Well, the quick answer is that it will take a pretty impressive financial history, says Chris Boulter, president of Val-Chris Investments, Inc., a California company specializing in residential and commercial loans.
"You're going to have to have very good credit and a stable work history," he says. That could start you toward getting a mortgage interest rate on a 30-year fixed rate loan that, as of September 6th, 2012, was a low 3.65 percent, according to Mortgage News Daily, an organization that provides housing news and analysis.
Boulter adds that if you don't qualify for the lowest rates, you could still qualify for rates that are typically a percentage point higher, which is still very good, historically speaking.
So don't give up just because your credit isn't perfect. Instead, read on for details on how to qualify for the best mortgage interest rates and what to do if you don't qualify.
Requirement #1 - Great Credit
Do you pride yourself on paying your bills on time? Good news. Mortgage lenders like to reward responsible bill paying with their best interest rates, says Boulter. In fact, he says credit score is the most important piece of information for the lender.
"Your credit score is the first thing a bank is going to look at," says Boulter. "They need to see a credit score in the very good to excellent category in order to qualify you for the most favorable rates."
And if you're wondering what very good to excellent is, Boulter says a score of 720 or above hits the mark, according to the Fair Isaac (FICO) scale, which most banks use. That scale, by the way, runs from a low of 300 to a high of 850, according to the Fair Isaac Corporation.
Want to find out what your credit score is? Good news: you are entitled to one free copy of your credit score every year. You can order it at securemycreditreport.org.
And if you don't like the results, there are some ways to improve your score. According to the FICO website, some tips include:
- Set up payment reminders so you always pay your bills on time. Paying bills on time is one of the biggest factors in your credit score.
- Reduce the amount you owe. Yes, this is tougher to do than say, but this is another biggie. Start by using your credit cards less.
Requirement #2 - Adequate Income
Banks usually want to know that you can pay them every month for the money they lend you - they're funny like that.
If you can show them that you are a good risk (in other words, that you have an adequate income to pay your bills, including your mortgage), you're in a better position to get a favorable rate, says Boulter.
"The top two priorities for the most favorable rate is your ability to show very good to outstanding credit and your ability to make the monthly payment," he says.
Generally speaking, says Boulter, lenders want to see that your total monthly liabilities (money owed) are not more than 40 percent of your total gross monthly income. Liabilities include such things as your car payment, credit card payments, student loan payments, property taxes, etc.
Also, don't forget that your new mortgage payment also counts as a liability included in that 40 percent. So if you want to qualify but are over the 40 percent threshold, try to reduce your liability by paying off credit cards or other loans.
Finally, Boulter adds that if you do happen to have a large income, with a lot of disposable income, that ratio could go up to 45 percent.
Requirement #3 - Stable Job History
It's no secret that many people have had disruptions in their employment in recent years. But if you're fortunate enough to have had a steady job history, you could save money in the form of a low mortgage interest rate.
"You typically need to have two years in the same job or at least in the same industry. And that's two consecutive years," says Boulter.
He says that if you have been laid off or had a period of unemployment in the past two years, your chances of qualifying for the lowest rates are unlikely. That's because lenders are more wary than ever before when it comes to risk. In fact, due to the challenging economy, banks have restricted loans to those who have a longstanding and steady income stream, says Boulter.
"It's tough, but that's today's reality," he says.
But what if you don't have a stable job history? There is still hope, says Boulter. You could qualify for a government subsidized program, such as a Federal Housing Authority (FHA) loan. These loans, designed for low-income households, typically carry a rate that's about one percent higher than the lowest current rate offered by commercial lenders.
What's more, these loans feature benefits like low down payments and easy credit qualifying, according to the U.S. Department of Housing and Urban Development, a government institution that works to strengthen the housing market.
Requirement #4 - Proof of Assets
Have you followed your parent's advice and been a responsible saver, saving a little cash for a rainy day? Well, if it's not currently raining, your savings could help you qualify for a good mortgage rate.
Boulter says that if you can prove you have adequate assets, the bank will be more willing to give you a good interest rate on your mortgage. The best asset is, of course, a savings account with cash, but other types of assets - or reserves - are things that can be easily cashed out, such as retirement accounts or pensions.
And just how big a flood do you need to plan for?
"Typically speaking, they want to see that you have a minimum of six months reserves that you can verify before they'll consider approving your loan," says Boulter. Those reserves have to be enough to pay all your liabilities, including your mortgage. "They're looking at your ability to keep yourself afloat should you hit rough water," he adds. Rough water could be losing your job or anything that hinders your income. Remember, the bank is funny about wanting to be paid back, so they need a guarantee that you can still pay them if you are unemployed for months on end. Basically, plan for the rainy day scenario.
Requirement #5 - Twenty Percent Equity
Is your home equity worth at least 20 percent more than the amount for which you want to refinance? Because that's what lenders will want to see in order to offer you the best rates, says Boulter.
Why? Because of that magic "risk" word again. You see, the difference between the market value of your home and the amount you still owe on your mortgage is called equity, and when your home loses value, your equity is the first to take a hit. But once your mortgage amount is more than the market value, your lender is in danger of losing money.
And here's a news flash: Banks don't like to lose money.
So if you don't have 20 percent equity, but want to refinance, Boulter says taking money out of other investments that are not earning decent returns could be a way to bolster your equity. By reinvesting that money into your home, you might then be qualified to refinance at a better mortgage interest rate.
It's important to make sure this will work for you financially, however. You may want an accountant or other money management professional to advise you, he says, since this is a big decision that could have long-term consequences. After all, that's sort of why you're doing it.