What's the best way to use savings to reduce a mortgage rate?

Posted by  on Oct 29, 2014

Q: I have about $5,000 in low-interest student loan debt remaining. I have more than enough savings to pay it off, but I wanted to hang on to some liquidity. However, now I'm thinking about buying a house. Will I get a lower interest rate if I pay that student loan debt off before I apply for a mortgage?

A: It is possible that paying off that debt might boost your credit score a few notches. It really depends on how your total monthly payments compare to your income. If mortgage lenders can be confident that you can easily make your monthly mortgage payments plus your existing loan obligations with your current income, you should be able to get a decent mortgage rate even with some debt outstanding -- provided you don't have any black marks on your credit record. There are a couple of other options, however.

One alternative is to put some of your savings into a bigger down payment on the house you intend to buy. A bigger down payment would lower the loan-to-value ratio of your mortgage, which can help you qualify for a lower mortgage rate. This is particularly true if you use some of your savings to beef your down payment up to 20 percent or more. However, if you are already planning to make a down payment of at least 20 percent, you may already qualify for a low rate.

A third possibility is to put your savings toward making larger monthly payments, which could allow you to substantially lower your mortgage rate by getting a shorter-term mortgage. With this approach, you could lower your rate without immediately having to give up the liquidity you have accumulated.

Of course, mortgage terms depend on a range of different factors, so you might want to discuss these different scenarios with some mortgage lenders, to see which would result in the lowest mortgage rates based on the specifics of your situation.


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