Mortgage lenders have many factors to consider when determining the interest rate they’ll offer you for your loan. Your credit score, debt-to-income ratio, employment history and down payment amount all play a role in the interest rate you’ll receive on your mortgage.
In addition to personal factors, market conditions also affect mortgage rates. The Federal Reserve, bond market, Secured Overnight Finance Rate, Constant Maturity Treasury and the health of the economy and inflation all contribute to changes in mortgage rates.
Your credit score is a three-digit number lenders use to help them decide whether to offer you a mortgage, credit card or other credit product, and what interest rate they will charge. They may also check it to screen you for rental housing or insurance.
Your score is based on your history of repaying debts, the type of accounts you have and how much you currently owe. This information is compiled by one of the three major credit bureaus–Equifax, TransUnion and Experian–and is then used in a mathematical algorithm to create your score.
A high score means you’re a responsible borrower who has a good track record of paying your bills on time and keeping your balances low. A low score shows that you’re a risky borrower who can’t be trusted to pay your bills on time or keep your debts under control.
Your debt-to-income ratio is one factor lenders consider when deciding whether to offer you a mortgage. It compares your total monthly debt payments with your gross income, which includes your take-home pay before taxes and other deductions.
Generally, large lenders want your ratio to be under 36%. But if your ratio is high, you might be denied or charged a higher interest rate.
To calculate your DTI ratio, add up all of your debt payments — including your housing costs and recurring credit card bills. Then, divide that by your income.
A good DTI ratio shows that you’re managing your debt responsibly and have the ability to afford additional loans. However, a high DTI might mean you need to reduce your debt or increase your income before your lender is comfortable providing you with a loan.
For a conventional loan, backed by Fannie Mae or Freddie Mac, most lenders accept a front-end DTI of no more than 28 percent and a back-end DTI of no more than 36 percent. But some smaller lenders will accept ratios of 50% or higher, depending on your credit history and assets.
Your employment history is one of the most important factors a lender will consider when assessing your application. It helps them determine if youll be able to make regular mortgage payments, whether youve had any gaps in your employment, and how much income you have.
In fact, the consistency of your employment record is so important that lenders will often look for an employment history that dates back more than two years. Having a recent gap in your job record can be a red flag, especially if its significant.
Lenders will need to see that youve had a stable income and paid off all your financial commitments during any gaps in your employment history. They also need to be confident that your current employment will be consistent, so its important to explain any gaps in your history and include any supporting documentation if necessary.
Down Payment Amount
The amount you choose to put down on your home affects several factors, including the mortgage rate. It also impacts your debt-to-income ratio, which lenders use to assess whether you can afford the mortgage payment and still meet other financial responsibilities.
Larger down payments can lower interest rates, because they make your loan-to-value (LTV) ratio smaller and appear to be less risky to lenders. In addition, a larger down payment can allow you to purchase a more expensive home because your mortgage payments dont take up as much of your income.
However, its not always the best choice for every buyer. For example, young homebuyers, low-income borrowers or people with high student debt may struggle to save up enough money for a down payment.