The interest rate is the cost of borrowing money whereas the APR is the yearly cost of borrowing as well as the lender fees and other expenses associated with getting a mortgage.The APR is the total cost of your loan, which is the best number to look at when you’re comparing rate quotes. Some lenders might offer a lower interest rate but their fees are higher than other lenders (with higher rates and lower fees), so you’ll want to compare APR, not just the interest rate. In some cases, the fees can be high enough to cancel out the savings of a low rate.
Mortgage rates are expected to rise through 2023 as inflation remains elevated and the Federal Reserve uses its monetary policy—called quantitative tightening—to tame inflation which places upward pressure on rates.
When you receive a mortgage loan offer, a lender will usually ask if you want to lock in the rate for a period of time or float the rate. If you lock it in, the rate should be preserved as long as your loan closes before the lock expires.
If you don’t lock in right away, a mortgage lender might give you a period of time—such as 30 days—to request a lock, or you might be able to wait until just before closing on the home.
Once you find a rate that is an ideal fit for your budget, it’s best to lock in the rate as soon as possible, especially when mortgage rates are predicted to increase. While it’s not certain whether a rate will go up or down between weeks, it can sometimes take several weeks to months to close your loan.
If you don’t lock in your rate, rising interest rates could force you to make a higher down payment or pay points on your closing agreement in order to lower your interest rate costs.
Locks are usually in place for at least a month to give the lender enough time to process the loan. If the lender doesn’t process the loan before the rate lock expires, you’ll need to negotiate a lock extension or accept the current market rate at the time.
Even if you have a lock in place, your interest rate could change because of factors related to your application such as:
- A new down payment amount
- The home appraisal came in different from the estimated value in your application
- There was a sudden decrease in your credit score because you are delinquent on payments or took out an unrelated loan after you applied for a mortgage
- There’s income on your application that can’t be verified
Talk with your lender about what timelines they offer to lock in a rate as some will have varying deadlines. An interest rate lock agreement will include: the rate, the type of loan (such as a 30-year, fixed-rate mortgage), the date the lock will expire and any points you might be paying toward the loan. The lender might tell you these terms over the phone, but it’s wise to get it in writing as well
First, start by comparing rates. You can check rates online or call lenders to get their current average rates. You’ll also want to compare lender fees, as some lenders charge more than others to process your loan.
Thousands of mortgage lenders are competing for your business. So to make sure you get the best mortgage rates is to apply with at least three lenders and see which offers you the lowest rate.
Each lender is required to give you a loan estimate. This three-page standardized document will show you the loan’s interest rate and closing costs, along with other key details such as how much the loan will cost you in the first five years.
Borrowers can get preapproved for a mortgage by meeting the lender’s minimum qualifications for the type of home loan you’re interested in. Different mortgages have different requirements. For example, a conventional mortgage usually has higher credit score and down payment requirements than government loans, such as Federal Housing Administration (FHA) and Veterans Affairs (VA) mortgages.
The most important task for a prospective homeowner seeking a preapproval letter is to gather all the financial paperwork needed to give the lender a solid picture of your income, debts and credit history. This information helps underwriters estimate how much of a loan you can afford and the costs of the loan.
The preapproval process will cover:
- Stable income. You’ll be expected to provide recent pay stubs, often the last two pay periods, that indicate how much you make and prove employment.
- Total assets. Your bank statements and investment accounts will provide a larger picture of how much money you might have available to cover your mortgage.
- Credit. A lender will run a hard credit check to look at your current score and the last several years of your credit history. Keep in mind that mortgage lenders look at a score from all three credit bureaus, which could be different than the FICO score you see on free score checking websites.
- Total debts. You will need to list the debts you have which helps the lender understand your DTI ratio, which is vital to determining how much of a mortgage loan you can afford.
In addition to your principal and interest payments, a monthly mortgage payment may also include several fees, like private mortgage insurance (PMI), taxes and homeowners association (HOA) fees.
Your lender will be able to provide you with a line-item breakdown of your mortgage payment. Using a mortgage calculator is an easy way to find out what your monthly payments will be. You can also look at an amortization schedule, which shows you how much you’ll pay over time.
Income is the most obvious factor in how much house you can buy: The more you make, the more house you can afford.
However, it also depends on how much of your income is already spoken for through debt payments as well as your credit score and history. The more debt you have, the less likely you will be approved for a mortgage or one at a lower interest rate. Your credit score also plays a role in that the higher your score, the better loan rate and terms you will receive.
And of course, if you have a larger down payment, it will help you in all these factors for affording a home.
At a minimum, lenders will total up all the monthly debt payments you’ll be making for at least the next 10 months Sometimes they will even include debts you’re only paying for a few more months if those payments significantly affect how much monthly mortgage payment you can afford.
Lenders primarily look at your DTI ratio. There are two types of DTI: front-end and back-end.
Front end only includes your housing payment. Lenders usually don’t want you to spend more than 31% to 36% of your monthly income on principal, interest, property taxes and insurance. For example, if your total monthly income is $7,000, then your housing payment shouldn’t be more than $2,170 to $2,520.
Back-end DTI adds your existing debts to your proposed mortgage payment. Lenders want this DTI to be no higher than 41% to 50%. Let’s say your car payment, credit card payment and student loan payment add up to $1,050 per month. That’s 15% of your income. Your proposed housing payment, then, could be somewhere between 26% and 35% of your income, or $1,820 to $2,450
Mortgage points represent a percentage of an underlying loan amount—one point equals 1% of the loan amount. Mortgage points are a way for the borrower to lower their interest rate on the mortgage by buying points down when they’re initially offered the mortgage.
For example, by paying upfront 1% of the total interest to be charged over the life of a loan, borrowers can typically unlock mortgage rates that are about 0.25% lower.
It’s important to understand that buying points does not help you build equity in a property—you simply save money on interest.