August 31st, 2015
Everybody knows that the lower your mortgage rate is, the lower the monthly payments on your home will be.
The difference between a 4 percent rate compared to a 5 percent rate may seem small, but that 4 percent rate can actually save you more than $100 per month over a span of 30 years compared to a 5 percent rate. That’s a difference of approximately $36,000 over the life of that mortgage, which can equate to things like college tuition money or savings toward retirement.
The mortgage rate for which you qualify will literally determine your budget on the market, and thus what houses are in your price range.
But even though most of us already realize how vital our mortgage rate is when shopping for a new home, few of us realize how our rate is actually determined. Many think it’s a direct reflection of their credit score, and while credit scores are certainly one element to calculating your rate, they are far from the only variable in the equation.
Yes, your credit score does indicate how well you pay off debt and how much more debt you can afford to take on. A higher credit score will tell a loan service you can be trusted to pay back your mortgage in a timely manner; a lower score says the opposite, often resulting in a higher rate due to the financier’s uneasiness about your ability to pay back the money.
But did you realize that your debt-to-income ratio (DTI) and financial assets are just as important as your credit score when calculating your mortgage rate? They are, and if you’re unaware of your financial situation it can really harm the rate you’re offered.
Your DTI calculates how much you spend per month in debt payments relative to what you earn in a given month. Essentially, it calculates how much of your monthly earnings you’re giving right back in the form of car payments, credit card bills, student loan collections, etc. If expenses like those occupy most of your monthly earnings, then many mortgage companies will find it risky to give you a loan with a low mortgage rate due to how much of your income is tied to other things.
Most loan services consider a healthy DTI to be anything below 36 percent. If payments toward debt occupy more than 36 percent of your monthly earnings, mortgage companies will likely consider you a risk, even if you make your payments on time and your credit score is desirable.
Of course, sometimes there’s nothing you can do about your DTI. Student loan debt can be unavoidable for some, especially in professions requiring an advanced degree like medicine or law. Car payments are another expense few can afford to live without, especially in areas without accessible public transportation. But even if you can’t affect your DTI to earn a better rate, knowing what your DTI is can make a major difference in your financial planning.
If you have a diversified portfolio with successful stocks and perhaps a healthy matching 401(k) plan, that can work in your favor. Even if your credit score is average and your DTI is high, if you prove you can maintain strong financial assets it will ease the nerves of most mortgage companies.
In their eyes, assets like these represent wealth outside of income. Even if most of your monthly earnings go to student loan payments and credit card bills, if your company is matching your 401(k) at 2.5 percent, that’s money you’re accumulating that your DTI does not take into account.
Likewise, if you own a vehicle outright, that’s now a possession with a value of a few thousand dollars in most cases. Because you own the car, its value is considered part of your net worth, and a higher net worth is going to help you earn a lower mortgage rate.
The lesson here is simple: Your credit score is important, but that alone will not determine your mortgage rate. Don’t put on blinders and lose sight of your assets or debt, as those, too, play a role in determining your rate.
Make sure you have a grasp on every element to your finances, and if you don’t then make sure you talk to one of the trusted professionals at Ace Mortgage about what rate you’d qualify for and what you can do to improve that rate. We’re here for you!