What Is a Mortgage Loan?
A mortgage is a loan used to
purchase real estate, often a primary residence. When you sign a mortgage loan,
you agree to repay a certain amount each month plus interest for the term of
the mortgage. Most mortgages last 15 or 30 years, but some lenders offer other
mortgage terms.
With a mortgage, the home or
property acts as collateral for the loan. If you do not make payments, the
lender can eventually repossess the home. If you want to change the terms of
your mortgage, you can apply to refinance for a lower interest rate or shorter
loan term.
Conventional mortgages require a 3%
down payment. They allow you to finance a home worth up to an annual
maximum established by Fannie Mae, a federally-based mortgage company.
Government-backed mortgages, such as FHA, VA, and USDA loans, have less strict
approval requirements. Jumbo mortgages exceed the threshold for conventional
mortgages.
What Is a Mortgage Rate?
Mortgage rates express the
amount of interest you will pay on your mortgage as a percentage. For
example, if you borrow $300,000 with a 5% fixed interest rate, you will pay
$15,000 in interest by the time you pay off your home (unless you pay more
toward the principal or refinance).
A variety of factors determine the
current mortgage rates, including economic indicators such as inflation and
unemployment as well as actions by the Federal Reserve. The rates change each
day, which is why most lenders post today’s mortgage rates on their
homepages.
Your financial history affects your
ability to qualify for the best mortgage rates. In general, you should aim
for a credit score of at least 740 if you want to save money on interest.
Lenders also look at the loan-to-value ratio (LTV) when determining home loan
rates. This number represents the amount you will borrow in comparison to the
value of the property. The LTV should be less than 80% for the lowest
mortgage rates.
The Impact of COVID-19 on Mortgage
Interest Rates
Already-low mortgage rates continued
to decrease as the COVID-19 pandemic arrived in the U.S. in the first half
of 2020. While the average APR crept up slightly as summer 2020 approached,
rates dipped again to a record low of 2.97% by early June.
With the effects of illness,
unemployment, and economic recession, many consumers struggled to qualify for
credit as the pandemic continued through the end of 2020 and into 2021. In
September 2021, sources reported a steady average mortgage APR of 2.88%.
As record-low rates continue into the end of 2021, slowing competition in many home markets makes it a good time to buy. If you already own a home, consider refinancing your mortgage if you can take advantage of lower payments and save money over the life of your loan.
How to Apply for a Low Interest Rate
If you want to qualify for the
lowest mortgage rates, follow these strategies to improve your chances.
Save a Sizable Down Payment
As mentioned, lenders look at the
property’s LTV ratio when setting home loan rates. The more you put toward your
down payment, the lower your LTV, which in turn lowers your interest rate.
Aiming for 20% can also save you money on the cost of private mortgage
insurance.
Do the Math Before You Pay Points
You can pay more money upfront at closing
in exchange for a reduced interest rate on your home loan. This practice,
called paying points, doesn’t necessarily save you money on home mortgage
rates. It can take almost a decade before you break even, so make sure it
makes financial sense before you move forward.
Consider an Adjustable Rate
Adjustable-rate mortgages often have
more favorable interest rates than fixed-rate mortgages, especially
during the introductory period. After the first three to 10 years,
the mortgage rate changes based on market conditions and can go up or down
depending on your loan documents.
Shop around for the best prices
Mortgage interest rates and other
costs vary dramatically from lender to lender. You can compare current interest
rates quickly by using a platform like Credible. The site provides quotes from
13 different home loan companies so you can check for the best mortgage rates.
How Does the Mortgage Loan Process
Work?
Once you submit all supporting
paperwork, your loan will enter the underwriting process. The lender will check
to make sure you have the credit and income to repay the loan and confirm other
aspects of your application.
The lender will also verify your
down payment and funds for closing. The underwriting agent will confirm the
source of large deposits in your account and confirm that you have cash
reserves. Many lenders require savings of at least two to three times your
monthly mortgage amount in reserve to complete the underwriting process.
During the mortgage application
process, the bank will order an appraisal of the home. They want to make
sure its value exceeds the amount of the mortgage loan. You may also want to
have a home inspector evaluate the property before you move forward with the
purchase. Some mortgages, such as FHA loans, require the borrower to get a home
inspection.
Three days before the scheduled
closing date of your mortgage, the lender must provide the closing
disclosure. This legal document provides the final terms of the loan as
well as the total closing costs. If the disclosure meets your expectations, you
make your down payment and closing costs at settlement, where you receive your
keys and take ownership of your new home.
Types of Mortgages
Within each of these main loan
types, most lenders offer either fixed-rate or adjustable-rate loans. You may
prefer the stability of the constant monthly payment with a fixed-rate mortgage
or prioritize the low introductory payments with an adjustable mortgage,
especially if you expect to increase your income over time.
Conventional loans allow you to
borrow up to a certain amount with a credit score of 620 or higher. You
must have a down payment of at least 3%. Most conventional loans have 15-year
or 30-year terms. Jumbo mortgages exceed the maximum amount for conventional
loans. They require a higher credit score and a down payment of at least 10%.
Average current interest
rates for conventional loans are 4.53% for a 30-year fixed mortgage, 3.85%
for a 15-year fixed mortgage, and 4% for a 10-year fixed mortgage. Today’s
mortgage rates for jumbo loans are 4.92% for a 30-year fixed mortgage and
4.15% with a 15-year term.
FHA loans allow a credit score of
500 with a 10% down payment or 580 with a 3.5% down payment. These loans
have a guarantee from the Federal Housing Authority and can be used to fund
both home purchases and renovations. Mortgage rates for FHA loans
currently average 4.99% for a 30-year term.
VA Loans, backed by the Veterans
Administration, provide zero-down mortgages for eligible veterans, service
members, and spouses. Home mortgage rates through the VA program
average 5.463% for a 30-year fixed loan.
USDA Loans: The USDA also has a
no-down-payment loan program. To qualify for this type of mortgage, you
must buy a home in a rural area. The USDA mortgage also has maximum income
limits depending on your family size and zip code. The current average mortgage
rate for a 30-year USDA fixed loan is 5.173%.
How to Choose the Right Mortgage
Lender for You
To find the best mortgage lender for
your needs, start by checking your credit score. If you have fair credit or
below, taking steps to improve your score can help you qualify for affordable
mortgage terms. You can build credit by paying bills on time, disputing
inaccurate information on your report, and reducing your overall amount of debt
(paying down credit cards, for example).
Once you’re ready to narrow your
search for a mortgage, start with lenders who offer the type of home loan you
want, or compare multiple lenders side-by-side on a site like LendingTree. Make
a short list of “musts” you want in your mortgage lender, such as online
servicing, limited closing costs, or a branch in your area for in-person
assistance.
Check online reviews and
customer ratings for the lenders on your list to look for potential pitfalls.
When you have three to four options, complete the preapproval process to access
your rates and terms. Read the fine print with your preapproval to make sure it
will not affect your credit score or compromise your personal information.
Next, review the lender term sheets next to one another to determine which loan will cost you less over time. In addition to the APR, pay attention to closing costs, origination fees, prepaid interests, and other expenses that can affect your monthly payment and the total cost of your mortgage.