When applying for a loan, one of the most important factors that will come into play is your credit score. Before you start the loan application process, you should have a clear understanding of how your credit score affects your mortgage rate so you can assess your financial situation.
Most lenders use the FICO (Fair Isaac Corporation) model for credit scores. This model provides consumers a numerical value on a scale between 300-850. Typically, the higher your credit score, the lower the interest rate the lender will offer to you. Lenders use your credit score to determine how reliable you’ll be as a borrower and the likelihood that you’ll repay the loan as agreed upon. Essentially, they want to make sure you’ll make your mortgage payments on time each month. A lower score might indicate that a borrower could make late payments or even miss some. This is all part of your credit history, which they will also take into consideration.
So, can a bad credit score ruin your chances at obtaining a mortgage?
Not necessarily. It mostly impacts which type of loan you’ll qualify for and the interest rate you’ll receive. A conventional loan usually requires a minimum of a 620 credit score, whereas an FHA loan has a minimum of 580. However, it’s important to note that while some loan programs accept lower credit scores, they might require a larger down payment or some other way to mitigate the lender’s risk in taking on the loan. In addition, even though someone with a 580 credit score COULD qualify for an FHA loan, it does not mean that they will; it is at the discretion of the lender within the guidelines of the loan programs.
Let’s look at an example of how a 100-point difference in credit score can impact a borrower’s mortgage payment.*
A borrower has obtained a conventional fixed-rate 30-year loan of $200,000 with 10% down, meaning the amount borrowed is $180,000. She has a 750 credit score and received a 4% interest rate. Her monthly mortgage payment is $859 (not factoring in other fees, such as private mortgage insurance (PMI) or real estate taxes that may be included in the payment). Now, say that borrower dropped to a 650 credit score. She instead received a 5% interest rate. That increases her monthly mortgage payment to $966. That 100 point difference between credit scores ultimately means an extra $107 added to her mortgage payment each month. While that might not seem like a big deal, keep in mind the duration of the loan is 30 years. Having a higher interest rate means a yearly difference of $1,284; over 30 years that totals $38,520.
If you’re interested in comparing interest rates and monthly mortgage payments, use our mortgage calculator.
If your credit standing isn’t ideal, there are ways to build your credit score.**
- Make payments on time – all of them (rent, credit, cars, etc.)
- Pay down existing debt
- Check your credit report and dispute any errors. Each credit bureau, Experian, Equifax, and Transunion, must provide a free copy of a credit report to consumers once a year. If planned properly, this means that you can get a free copy of your report every four months.
Don’t worry if your credit isn’t the best right now. Raising your credit score can take a lot of time, patience, and discipline. However, if you follow these simple guidelines you will soon notice a positive change in your credit and ultimately your financial future. You’ll be able to qualify for better rates when it’s finally time to buy a home.
To learn more about credit scores and interest rates, contact one of our licensed Mortgage Loan Originators. If you are ready to begin the home buying process, click here to get started!
*The figures used in this example are hypothetical and the results are intended for illustrative and educational purposes only. **Main Street Home Loans is not a credit repair company. Please contact a credit repair company for more information on how to improve your credit score.