The vast majority of people buying a new home need a home loan to cover the costs. With the help of a bank, you can afford a home by providing as little as 5 percent of the purchase price as a down payment. They’ll loan you the rest of the money, and give you a clear payment plan you can follow to pay that money back over the course of 15 or 30 years.
Of course, each year, you’ll pay interest on the principal you borrowed, and over time, that interest can seriously add up. A difference of just one percentage point can add up to $1,000 per year in extra part on a loan of $100,000. Over the lifetime of the loan, that can add up to tens of thousands of dollars, and every month, that amounts to hundreds of dollars more in monthly expenses.
Accordingly, it’s in your best interest to get the best interest rate possible—but how can you do it?
Improve Your Credit Score
One of the best steps you can take is increasing your FICO credit score. Your credit score is a measure of your financial reliability or trustworthiness, and lenders will use it to determine the level of risk they face when lending to you. Generally, the higher your credit score is, the more likely you’ll be to qualify for a loan—and the lower the interest rate you face. Homebuyers with impressive credit scores can often get home loan interest rates far lower than people with questionable scores.
Increasing your credit score is a process that takes time—sometimes months—but it’s a reliable method to score better interest rates. Start by committing to paying all your bills on time, every time. Then, work to pay down your debts by consolidating those debts, reducing your other expenses, and increasing your income. You’ll also want to avoid opening any new accounts, which can temporarily ding your credit score.
Shop Around and Negotiate
Next, shop around. Many homebuyers, especially new ones, sign up for a mortgage with the first bank or lending institution that offers them one. Instead, it’s almost always better to shop around, looking at interest rates and terms from a variety of different banks. You may find that a different lender is able to offer you a much lower interest rate and/or much more favorable terms.
When you start working with a lender, negotiate. Sometimes asking for a lower rate is all it takes to get one.
Pay Close Attention to Terms and Conditions
Before you sign up for an attractive, low-interest rate loan, pay close attention to the terms and conditions of that loan. How many years is this loan for? How much are you paying in other fees and associated costs? Importantly, is this a fixed-rate loan or an adjustable rate mortgage? If the latter is the case, your interest rate may fluctuate over time, eventually exposing you to a much higher interest rate. It’s better for most consumers to lock in a rate with a fixed-rate mortgage.
Increase Your Down Payment
Though this strategy won’t often directly reduce the interest rate you pay, you can reduce the interest you pay on a recurring basis by increasing the amount of money you put into your down payment. Most banks will offer a loan to people if they provide a down payment of at least 5 percent. If you want to avoid private mortgage insurance (PMI), you’ll likely need to provide a down payment of 20 percent or more; this is the recommendation for many homebuyers.
The higher your down payment is, the less you’ll need to borrow as principal in your home loan, and the less interest you’ll pay. You can increase your down payment by waiting longer to buy a home, reducing your expenses, and increasing your income.
Shorten the Payment Terms
This is a financially aggressive strategy that won’t work for everyone, but if you want to reduce the total amount of interest you’re going to pay, you can also shorten the payment terms. Instead of paying the loan over the course of 30 years, establish payment terms of 15 years; you’ll skip out on 15 years of interest payments, ultimately saving you tens of thousands of dollars. Of course, the consequence of this is that your monthly payments will be higher, putting a larger burden on your recurring finances.
There are many valid strategies to reduce the interest rate you pay on your home loan, or at least reduce the total amount of interest you pay. Later on, if you’re still in the same home and interest rates fall, you can use home refinancing to score a better rate.