The constantly changing average interest rate on a 30-year fixed rate mortgage is currently hovering near 4.23%, but only the most qualified borrowers are able to lock in these rates.
Here's why: you have to pay a 20% down payment in order to qualify, and few people -- even those with excellent credit -- can afford the expense.
According to an Associated Press analysis of FICO data and the National Foundation for Credit Counseling, around 40% of Americans have excellent credit ratings, but fewer than 50% say they can afford to save for down payments.
This might be the best time in most Americans' lives to invest in a home, but most can't afford it. They also can't afford not to…
Crunching the (Magic) Numbers
A fixed rate, 30-year loan for a $250,000 home with a 4.23% interest rate has a monthly payment of $1,226.92, with $191,692.77 in interest paid over the lifetime of the loan.
[For help crunching your numbers, check out our Mortgage Calculator for Fixed Rate Mortgages]
Compare that with a slightly higher 4.75% interest rate, which has a monthly payment of $1,304.12. That is not much of a difference monthly, but over 30 years, the interest you pay ends up being $219,482.60 – a difference of $27,789.83.
At a fixed rate of 5%, the numbers balloon to $1,342.05 a month and $233,139.46 in interest over the course of the loan -- a difference of $41,446.69.
The numbers keep growing, as illustrated in the chart below:
Qualifying for these historically low interest rates requires you hit the magic numbers -- a credit rating greater than 760 and a down payment of 20%. Here are steps you can take to ensure you have the best chance of being approved.
Start Saving for the Down Payment Now (If You Haven't Already)
Down payments can be steep, especially if the house you want is expensive. For a $250,000 house, a 20% down payment is $50,000. It takes most people quite a while to save that much money, so if you haven't already started saving, now is an ideal time.
Think of the cash you will save with a low interest rate as a long-term investment. Remember, a lower interest rate can save $41,500 over 30 years, or approximately $1,400 a year. Isn't that worth tightening your budget now for that kind of savings later?
A 20% down payment also means that you don't have to pay private mortgage insurance (PMI), which offsets losses to lenders if you are unable to repay their loan. PMI costs between $50 and $80 per month.
Keep YourBalances Low
One factor used to determine your FICO score is the amount of credit extended to you and how much of it you are utilizing. The powers that determine your credit score prefer you exercise your credit, but to a certain extent.
People awarded a credit score of 760 or greater typically have a balance on their credit cards that represent 7% of their card limits.
If you have $10,000 worth of credit on your credit card but continually run a balance at $700 or less, you have a much better chance of being awarded a credit score at or near that magic number 760.
[For more on credit card balances, read 10 Ways to Dig Yourself Out of Credit Card Debt]
If paying off your credit card balances is impossible, you can help improve your debt-to-credit ratio by asking one of your credit issuers to increase your credit limit. This will effectively decrease your debt ratio and help your credit rating.
Just make sure you request that they don't check your credit in the process. Each credit check done has the potential to ding your credit rating, so limiting them is vital.
[For more on building and extending your credit, read 7 Steps to Perfect Credit]
…But Don’t Apply For New Credit Cards
Your credit score will be affected by new credit in many ways, and not all of them are good for your score. That means getting new credit cards in an effort to boost your score might hurt instead of help.
Every time you apply for a new credit card, your credit gets run by the credit card company. As we stated earlier, every credit check puts a ding in your score. When determining your credit score, FICO looks at the number of accounts open, the number of credit inquiries and time since the credit inquiries.
Too many inquiries could negatively affect your score when trying to get approved for a 30-year fixed-rate mortgage.
[To avoid unintentionally hurting your credit, read 9 Seemingly Innocent Ways to Severely Damage Your Credit Score]
The Investing Answer: If you are able to hit the magic numbers -- 20% down payment and a 760 FICO score -- you may just qualify for the lowest interest rate of your lifetime. A tighter budget and some credit building tactics over the short-term can result in a historically low mortgage rate and thousands of dollars in savings over the long-term.
Photo courtesy of Flickr.
Personalized Financial Plans for an Uncertain Market
In today’s uncertain market, investors are looking for answers to help them grow and protect their savings. So we partnered with Vanguard Advisers -- one of the most trusted names in finance -- to offer you a financial plan built to withstand a variety of market and economic conditions. A Vanguard advisor will craft your customized plan and then manage your savings, giving you more confidence to help you meet your goals. Click here to get started.