Getting the best interest rate on your mortgage can save you tens of thousands of dollars over the life of the loan, and surely you've got better things to spend money on than paying your bank interest. Knowing ahead of time what lenders look for, and what can derail your chances of getting the lowest rate, can help you prepare for a future mortgage application.
Bad Credit Score
Your credit score, in just three digits, summarizes your risk of default to the lender. If you have a low credit score, that tips the lender off that you're a more risky borrower. To compensate for the higher risk of lending you money, the bank charges you a higher interest rate. According to the Fair Isaac Corp., which created the most widely used credit scoring algorithm, you need a score of 760 or better to qualify for the lowest interest rates.
High Debt-to-Income Ratios
Of course, even with a perfect 850 credit score you're not going to get the best mortgage if your mortgage payment is going to take up 80 percent of your income. Lenders typically look at two debt-to-income ratios when evaluating mortgage applications. The front-end ratio measure how much of your gross monthly income your mortgage expenses take up. Most lenders want this ratio to fall below 28 percent. The back-end ratio, which measures how much all of your debt payments account for as a percentage of your monthly income, shouldn't exceed 36 percent. The lower your ratios, the better interest rate you'll get on your mortgage.
Down Payment Size
If you do default on your mortgage, the bank can recover at least part of what you owe by foreclosing on your home and taking proceeds from the foreclosure sale. However, if you owe more than your home is worth, the bank won't be fully compensated. The larger your down payment, the smaller the bank's risk that it won't get its money back. So, if you can afford a large down payment -- 20 percent or more is best -- you'll get better mortgage terms. Not only that, but a larger down payment means borrowing less money, so your debt-to-income ratios go down as well.
When you need a bigger mortgage than the conforming loan limits, the bank can't sell the mortgage to the government or other investors as easily. Plus, because the loan is larger, it's riskier for the lender. Therefore, lenders charge higher interest rates on jumbo mortgages than they do on conforming mortgages. As of 2013, the general limit on conforming mortgages is $417,000. However, in certain high priced areas, including all of Hawaii and Alaska, the maximum amount of a conforming mortgage can go as high as $721,050.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."