With only four months remaining in 2017, now is as good a time as many to be reminded of some valuable do’s and don’ts of mortgage financing.
Know Your Credit Score
Lenders review your credit report to determine if you qualify for a loan and at what rate. It’s free to check: By law you are entitled to one free credit report every year from each of the “big three” credit rating agencies: Equifax, Experian and TransUnion. Take a close look at your credit report to make sure it’s accurate, and if there are mistakes, take steps to fix them. In particular, watch out for things such as debts that have already been paid, information that isn’t yours (due to a mistake or identity theft), data from a former spouse that shouldn’t be there anymore, out-of-date information and incorrect notations for closed accounts.
Do Improve Your Credit Score
In general the higher your credit score, the better mortgage you’ll get, so it pays to do what you can to achieve the highest score possible. The most common credit score is the FICO score, which many financial institutions provide for free to their customers each month; otherwise, you can purchase your FICO score from one of the “big three” credit rating agencies. To improve your credit score, pay down debt, set up payment reminders to pay your bills on time, keep your credit card and revolving credit balances low and reduce the amount of debt you owe (e.g., stop using your credit cards).
Do Lower Your Debt-to-Income Ratio
Lenders look at your debt-to-income ratio to measure your ability to manage your monthly payments and to determine how much house you can afford. Lenders like to see debt-to-income ratios lower than 36%, with no more than 28% of that debt going toward mortgage payments (this is called the “front-end ratio”). The stronger these ratios, the better your mortgage rate.
There are two ways to lower your debt-to-income ratio so you get a better mortgage rate (and neither is easy):
- Reduce Your Monthly Recurring Debt – Stop spending money on anything but the most urgent purchases.
- Increase Your Gross Monthly Income – Get a second job, work extra hours, take on more responsibility to get a pay increase or complete course work/licensing to increase your earning potential.
Don’t Take on Too Much House
Lenders are less likely to qualify you for loans that exceed your ability to pay. Still, it’s worth considering that just because you qualify for X amount doesn’t mean that you have to spend that much on a home.
A conservative approach is to spend no more than 30% of your take-home pay on housing costs, which includes your mortgage, property taxes, homeowner’s insurance and homeowner’s association dues – plus maintenance costs if you really want to make sure you’re looking in the right price range. When shopping for homes, decide what’s more important: having that more expensive home or having a little extra wiggle room in your budget each month – and remember that’s a 30-year commitment.
Don’t Count on Refinancing to Lower Your Interest Rate
Mortgage rates are expected to climb during 2017, so it might not be the year to refinance if you’re aiming to lower your rates – depending, of course, on your current rate. That said, you may be able to save money by shortening your loan term – for example, moving from a 30-year fixed-rate mortgage to a 15-year one with a better rate – or through cash-out refinancing, in which your new mortgage amount is greater than the existing one. This allows you to tap into your home equity to pay down other debts. Even though your monthly payment will rise, you could end up saving money by paying off higher-interest debt, such as your car loan, student loans and/or credit cards.
Before doing any type of refinance, it’s important to crunch the numbers to ensure that it makes financial sense.
The Bottom Line
Homebuyers can expect to see rising mortgage rates in 2017. Even a small change in rates can make a big difference in monthly payments, the amount of interest paid over the course of the loan and the size of the loan (and house) for which you’ll qualify. If you have a $200,000 30-year fixed-rate mortgage at 4%, for example, your monthly payment would be $954.83, and you’d pay $143,739.01 in total interest. Bump the rate up by 0.5% (for a total of 4.5%), and you’d be looking at a monthly payment of $1,013.37, and your total interest paid would be $164,813.42 (that’s about $2 more per day – for 30 years).
Given the above, the remaining 2017 months are still a good time to work on improving your credit score, credit history and debt-to-income ratio, so you can qualify for the best rate available. And, of course, don’t take on more house than you can comfortably afford.