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Deciding on a down payment amount for a new mortgage involves many considerations, but the effect it may have on your interest rate is a crucial one. Because larger loans present more risk, your lender may offer you a lower rate in exchange for more money upfront. Conversely, they may raise your rate if you offer a smaller down payment.
Let's dive deeper to better understand how a larger down payment and other factors can directly impact your interest rate.
Can a Larger Down Payment Lower Your Interest Rate?
The amount of your down payment directly affects several factors of your mortgage, including your annual percentage rate (APR), monthly payment amount and the possibility of mortgage insurance payments. The amount you put down also affects the type of loan you qualify for, as some loans have minimum down payment requirements that exceed what many homebuyers can afford.
For example, conventional loans typically require a down payment of at least 5%, but some lenders may accept a 3% down payment for certain types of loans. Remember, however, you'll usually need to pay for mortgage insurance if you put down less than 20%.
Here's a breakdown demonstrating the potential difference in your monthly mortgage payment and total principal and interest costs for various down payment amounts on a $400,000 conventional home loan.
| Mortgage Down Payment Cost Comparison | |||
|---|---|---|---|
| Down Payment | Interest Rate | Monthly Payment | Total Principal and Interest Cost |
| 3% | 6.75% | $2,517 | $905,962 |
| 5% | 6.00% | $2,278 | $820,185 |
| 10% | 5.50% | $2,044 | $735,855 |
| 20% | 4.50% | $1,930 | $583,702 |
Note: These figures are for illustrative purposes only and are not a guarantee of rate schedules you may encounter. Rates, and the factors that comprise them, vary by lender.
As you can see, increasing your down payment could potentially save you hundreds of thousands of dollars over the life of the loan, provided your lender offers lower rates for larger down payments—however, not all lenders do.
What Factors Influence a Loan's Interest Rate?
While putting more money toward a down payment may help you secure a reduced interest rate, it's not the only way to lower your rate. Mortgage lenders consider several factors to determine your mortgage interest rate, including the following:
- Down payment: As mentioned, the size of your down payment can impact your interest rate as it roughly correlates to the level of risk your lender takes on. Remember, a larger down payment means less risk for the lender and, potentially, lower rates. A larger down payment can also help you avoid paying for mortgage insurance.
- Your credit report and score: Your lender will review your credit report and payment history to gauge your creditworthiness and how well you've historically managed your debt. Additionally, your credit score may need to meet your lender's minimum credit score requirement for approval. Generally, the higher your credit score, the better your loan approval odds. The best mortgage rates are often reserved for those with 740 or higher credit scores.
- Loan-to-value (LTV) ratio: The loan-to-value ratio compares the amount of your mortgage with your property's appraised value. By putting down a larger down payment, you'll lower your LTV, have more equity in your home and potentially lower your interest rate.
- Repayment term: Loans with shorter repayment terms typically have lower interest costs but higher monthly payments than longer-term loans, and vice-versa.
- Interest rate type: Interest rates are either fixed or adjustable. Fixed rates remain the same over the life of the loan, while adjustable rates can fluctuate based on market conditions.
Of course, interest rates are also influenced by broader economic conditions, including inflation rates, the bond market and the federal funds rate. Generally, rates tend to rise in a strong economy and fall in a down one.
How to Get a Lower Interest Rate on a Mortgage
Buying your home when rates are low, choosing a shorter loan term and improving your credit score are just a few ways to lower your mortgage interest rate without putting more toward a down payment.
- Lock in rates when they're low. You can save significantly on interest costs by locking in a mortgage rate when rates are lower. Even a 1% rate drop may reduce your monthly payment by hundreds of dollars and save you thousands of dollars over the term of your home loan.
- Opt for a shorter loan term. You may also save on interest by going for a shorter loan term, such as a 15-year term rather than the traditional 30-year mortgage. Bear in mind, though, while this strategy reduces the total interest you pay over time, it also means larger monthly payments.
- Buy points. Another option is to purchase mortgage points from your lender when you close your loan to reduce the interest rate on your mortgage. When you purchase points, you're essentially prepaying for some of the interest at closing to secure a lower ongoing interest rate.
How to Improve Your Credit for Better Mortgage Interest Rates
One of the most impactful steps you can take to snag lower rates on a home loan—or virtually any credit product—is to improve your credit score. With a higher credit score, lenders may view you as a less-risky borrower who is more likely to repay your loan on time. Here are a few steps you can take to improve your score:
- Access your credit report and credit score. Get free access to your credit reports maintained by all three credit bureaus—Experian, TransUnion and Equifax—at AnnualCreditReport.com. You can also get your Experian credit report online for free through Experian, and check your FICO® Score☉ at no cost. If you find information in your credit report you believe may be in error, you have the right to dispute information on your credit report.
- Make consistent, on-time payments. Your payment history is the most important factor of your credit score, accounting for 35% of your FICO® Score, the score used by 90% of lenders, so it's essential you pay all of your bills on time.
- Keep your debt balances low. Your credit utilization ratio—the amount of your available credit you're using—accounts for 30% of your credit score. As a general rule, the lower your credit utilization ratio, the better. Individuals with the highest credit scores tend to have a credit utilization rate in the low single digits.
- Pay close attention to your credit history. The length of your credit history accounts for 15% of your credit score, with longer histories typically leading to higher scores. Credit scoring models often consider the age of your oldest and newest accounts, along with the average age across all accounts. As such, consider holding off on canceling an old credit account to avoid risking a credit score drop when you apply for a mortgage.
- Avoid opening new credit lines. When you apply for credit, the resulting hard inquiry can stay on your credit report for two years. Hard inquiries may cause a minor, short-term dip in your credit score.
Monitor Credit During The Mortgage Process
If you're preparing to apply for a mortgage, you want to maintain the best credit score possible to improve your loan approval odds and ideally score a lower interest rate. Consider monitoring your credit regularly with Experian to help you detect identity fraud sooner and stay on top of any potential credit issues that may arise. You can also utilize an interactive FICO® Score tracker to monitor your progress over time and receive alerts when there's a change to your credit score.