Learning how to get the best mortgage rate is an important part of getting a home loan. With larger loan amounts and larger interest rate differences, you will notice the impact on your monthly payment, too. Here is what you should know to get the best interest rate.

What Is A Mortgage?

A mortgage is a type of loan that uses your home as collateral. It is typically used to buy a home or in refinance situations to secure a more favorable deal and possibly convert equity in your home to cash. If you have the resources, you could consider paying with cash, but most people either do not have that option, do not want to deplete their life savings or divert money from other investments. Plus, mortgage interest is usually deductible from your taxes.

You usually have one mortgage tied to your home at any given time. However, one of the ways to access home equity is to take out another mortgage that takes a second priority. You can also do a refi to fold your second mortgage back into a primary mortgage. We will touch on why you might do that a bit later.

Calculating Mortgage Rates

If it is your first time really dealing with mortgages, it can be tempting to think that a lender is setting their price arbitrarily based on a profit margin. While lenders do have the flexibility to control their rates to an extent, the need to compete keeps rates from being too out of whack from one lender to the next. No matter where you are starting from, and whether you are applying for your first mortgage or you are fifth, following these steps to get the best mortgage interest rate can save you real money—especially over the long run. These tips can help you whether you are buying a home or refinancing.

Work on Your Credit Score

If your score is below 760, it’s worth the effort to improve your credit score by taking steps to pay down your balances and make all your payments on time. Having excellent credit will make you eligible for the lowest mortgage interest rates. The Loan Savings Calculator from myFICO is a great tool for estimating how much you could save on your mortgage by improving your credit score.

If you are putting down less than 20% on a conventional loan, excellent credit will also make you eligible for the lowest mortgage insurance rates. But even if you have bad credit, you might be surprised by your loan options.

Consider a Shorter Loan Term

When you take out a 15-year fixed-rate mortgage instead of a 30-year fixed-rate mortgage, the interest rate will normally be lower. In mid-September 2020, for example, the 30-year rate was 2.87%, and the 15-year rate was 2.35%. You also could consider an adjustable-rate mortgage. Its introductory rate may be lower than what you could get on a fixed-rate mortgage. It depends on the market, though: In mid-September, a 5/1 ARM had an interest rate of 2.96%.

Even if you can get a lower rate on an ARM, you’re taking a risk. It might be cheaper in the short term, but it could be more expensive in the long term. Why? No one knows what interest rates will look like when the ARM’s introductory period ends. There is no guarantee you’ll be able to refinance or sell when the ARM’s introductory period ends.

Increase Your Income

All else being equal, who would you rather lend money to? Someone who earns $7,000 a month will have to spend $3,000 (42.8% of their income) on their mortgage and other debt payments. Someone who earns $8,500 a month will have to spend $3,000 (35.3% of their income) on their mortgage and other debt payments. If you want to minimize your risk, you will.

The higher your income compared to your debt, the less trouble you will have managing your finances in tough times. If your finances indicate that you are someone who will keep paying if something goes wrong, lenders may offer you a lower rate. Ideally, your debt-to-income (DTI) ratio should be 36% or less.

Watch Mortgage Rates

Rates will fluctuate constantly. The short-term changes tend to be small, but you want to lock your rate when it is at a level you can afford. If you can lock your rate when rates are trending down, even better. Prepare to take advantage of a possible rate drop by knowing what rates have been doing lately. When rates move in your favor, ask your lender to lock your rate.

For example, someone shopping for a 30-year fixed-rate mortgage in September 2020 would want to be aware that over the last year, average rates have ranged from a high of 3.78% in October 2019 to a low of 2.86% in mid-September, according to Freddie Mac’s Primary Market Survey. The strongest borrowers should expect to lock their rate close to 2.86% if they are paying 0.8 in fees and points.