Debt ratio

Your debt ratio is the amount of debt you have in relation to your monthly income, expressed as a percentage or fraction. If your income is $4,000 and your monthly debts equal $2,000, your debt ratio is 50%.

The higher your debt ratio, the higher your interest rate. If your debt ratio is under 36%, including both your monthly debts and your mortgage payment, you should be in a position to command the lower rates. Ratios in the 40% range and above will bump your rate up. Ratios above 45% and into 60% can push you into the subprime mortgage world, where the rates are substantially higher than conventional mortgages.

It’s an unfortunate paradox that mortgage companies charge higher rates with higher debt ratios. A higher rate equals a higher payment, which equals a higher debt ratio.

Type of mortgage

The type of mortgage you apply for will affect your rate. In general, a fixed rate mortgage has higher rates than an adjustable rate mortgage. Between fixed and adjustable mortgages are hybrid mortgages that have both characteristics. A 3/27 mortgage, for example, means that the interest rate is fixed for the first 3 years. After that, it becomes an adjustable mortgage for the remaining term of the loan. This type of mortgage is great for people who might look to move before 5 years. It’s also great for those rebuilding their credit. You can take 3 years to rebuild while the rate is fixed. Before the mortgage becomes adjustable, you can refinance into a fixed rate with your newly-rebuilt credit.

The hybrid’s interest rate will fall somewhere between a fixed and an adjustable. Sometimes, however, you might be better off going with a fixed rate loan at a slightly higher rate. The rate difference between the two might only add up to a savings of $20 to $50 per month. You’ll then have the hassle of refinancing in a few years, which could cost you more fees.

Term of mortgage

The term of your mortgage, or the number of years that your mortgage is in effect, affects your rate. Usually, a 15-year fixed-rate loan will have a lower rate than a 30-year fixed-rate loan.

Negotiation Skills

Believe it or not, interest rates are not set in stone. In many cases, they can be negotiated. In the first part of this article series, we discussed the “par” rate. Lenders work off the par rate to determine how much interest to charge you. Sometimes they will charge you anywhere from 1% to 2% above par, depending on what they think they can get away with.

If you can somehow get the lender to divulge the par rate, you can try to haggle the interest rate down to that level. It’s akin to seeing the invoice for a new automobile and using that as your negotiating target. While you likely won’t get the actual par rate, you might get something better than what you were originally offered.

Credit Score

Perhaps the biggest determinant of your interest rate is your credit score and overall credit history. Your score determines whether you pre-qualify for a conventional or government mortgage, or a subprime mortgage. The interest rate varies widely among these products. Generally, the higher your score, the lower your rate, pending the application of the other factors we’ve mentioned. But in most cases, your score determines your starting point.

To qualify for the best possible interest rates, you must be aware of your credit score. Obtain a copy of your credit report from the three major credit reporting bureaus. Determine what is keeping your score from being as high as it might be and take steps to boost your score. Once you do, you’ll be in a greater position to take advantage of your knowledge of interest rate determinants. While you shouldn’t shop for mortgages asking for interest rate alone, you’ll get the best possible deal when your credit scores are the highest they can be.