After deciding on the best type of mortgage for your situation, and choosing a lender it is necessary to understand what factors will influence your monthly payment, and what one can do to ensure they reach the best payment structure for their new home.
As discussed in the previous articles about the types of mortgages and lenders your rate for the mortgage is based on the risk the lender feels that mortgage will be subject to. One way to measure this risk is the credit profile of the borrower.
To analyze this, they will pull your credit score as well as credit history, and review each for signs of what your previous financial behavior has been like. The factors the lender will take into consideration are as follows:
Your credit score will show how long you have maintained each of your sources of credit, and as a general rule, the longer your credit history, the more favorable it looks to the lender.
Most lenders tend to predict future behavior from what they can observe from the past, which in this circumstance is the number of late or delinquent payments on your credit report. The lender will also take into account when these delinquent payments occurred, and the more recent these appear, the worse for you as the borrower. Recent delinquent payments can negatively affect your interest rate, and terms of the mortgage.
Once the lender knows the amount of credit you have at your disposal, they will then evaluate how much of that credit you are using. The closer you are to ‘maxing out’ the more risky you will appear to the lender.
The borrower’s mix of credit (revolving, installation) is also taken into account by the lender. If the level is a blend, it is often viewed as less risky than solely credit card debt.
Overall, the higher your credit score, the better your terms will be from the lender. This all goes back to the risk profile associated with each borrower.
Before applying, it is important to know what is on your credit report, as there are sometimes errors which could end up costing you in terms of your interest rate, and in turn, cold hard cash.
Once you obtain your credit report, it is important to do a few things:
Review the entire report for errors, or items which you do not recognize
Take note of delinquent or late payments
Remedy any outstanding balances
Ensure the accounts shown are actually yours
Pay down your credit cards
A second important point many borrowers wonder is how the interest rates advertised by lenders are set.
For the most part, the rates are not set by the individual lenders, but by the secondary markets, the institutions buying the mortgages made by these lenders.
Rates are primarily determined relative to the current risk free rate. Typically, the 90 day US Treasury bill is used for this benchmark. From here, the banks add premiums to this rate to compensate for additional risks, as a mortgage is not ‘risk free’. These additional risks include an inflation premium, a default risk, a liquidity premium, and a maturity premium.
So adding all these risks to the current 90 day US Treasury rate, the bank gets a ballpark idea of the rate they will charge.