Get a Better Interest Rate - the "How to"
With all the doom and gloom news about the housing industry lately, you might think it’s impossible to get a mortgage right now. Not true – but, you will have to get your financial act together. Clean up your credit, have money in the bank for a down payment, closing costs, several months’ worth of reserves, and be able to prove through your income and stable job that you will be able to handle a mortgage payment. Mortgage lenders have become pickier about whom they will lend money to. (Note: VA financing does not require a down payment.)
There are no longer the loosey-goosey rules that enabled 'credit challenged' people to obtain mortgages they couldn’t afford and shouldn’t have been given.
Mortgage lenders will be closely looking at your income, your debts (car loans, credit cards, educational loans, etc. - anything where you borrowed money), if you still owe it, and your credit history. If you have debts totally $100,000 (not including a mortgage), but your income is only $25,000 a year – that’s going to be an enormous red flag to a mortgage lender. If you find a mortgage lender who will give you a mortgage under those circumstances – RUN AWAY FROM THAT LENDER AS FAST AS YOU CAN!
At a minimum, lenders will require documents such as the past two years of your income tax returns and your W-2 annual wage statements, the past two months’ bank statements to show you have money in the bank for a down payment and closing costs. They’ll also want you to have two months of at least the mortgage payments in liquid assets that you can easily access. If your down payment is $6,000 and your closing costs are $4,000, they will want to verify that you have $10,000 in the bank. If your house payment is $2,000 a month, they’d like to see an extra $4,000 left over in the bank or in other liquid assets after closing so you won’t be broke when you move into your new home.
To get the better interest rates, here’s what you need to do:
- Clean up your credit - Mortgage lenders are requiring very good credit scores to get the better interest rates. The scores reach to 850.
- The most important item is to PAY YOUR BILLS ON TIME – Payment history constitutes more than 1/3 of your FICO score. If you missed payments, get current and STAY current. The longer you pay your bills on time, the better your score becomes. Bills include credit cards, car payments, school loans, etc. - anything where you have borrowed money.
- Pay off or pay down your debts as much as you can. How much debt you owe makes up 30 percent of your FICO score.
- Keep the balance on your credit cards within 25-35 percent of your available credit - less is better. If your credit limit on a charge card is $20,000 – don’t have a balance of more than $7,000 on that card. Your actual credit limit ISN’T as important as the PERCENTAGE that you have actually used. In fact, try to carry low balances. The idea is to NOT use all your available credit, to show that you make all your payments on time or that you pay it all each month. Your credit report will show how many payments you’ve missed and how late those payments were (30, 60, 90, 120, etc. days late). One late payment a year isn't too bad, but you better have a really good reason for being late or you’ll be seen as a credit risk.
- Don’t close out older credit card accounts and don’t open any new credit card accounts before you apply for a mortgage. Either action could affect your score negatively. FICO scores also take into account the length of the older credit card’s history - you’ll erase your “credit history” if you close that account. If your older credit card is still active but you haven’t used it in a long time, charge something cheap on it to keep that credit history alive. If you get a new credit card, it will demonstrate that you now have additional available credit and that puts you in more of a position as a risk to the lender. Getting more credit cards means you have more credit but it sends a red flag to the lender of “how are you going to be able to make all these monthly payments AND a mortgage too?” Stick to two major company credit cards and only one revolving account (department store cards - Target, JC Penney, as examples). But, make all these payments ON TIME.
- If there are any unpaid judgments on your credit report, get those paid off and get official receipts that you paid the judgments.
- If there are any charge-offs or write-offs, be prepared to explain in writing why.
If you do all these things, in time, your credit score should improve substantially which should put you in a better position to get a better mortgage rate.
Many times people believe they have “good” credit because they were able to get a car loan with no problem (“The salesman said my credit was good!”). If the interest rate on a car loan for someone with really good credit is, as an example, 6%, but your car loan interest rate is 11% - that should be a big red flag to you that your credit needs some serious repairs.