How Much a Great Credit Scores Can Save You on a Mortgage
Getting a great interest rate on your mortgage loan goes a long way in making your monthly mortgage payments affordable. And having a good credit score will help you to land that great interest rate on your home loan.
Here, we take a closer look at how your credit score could affect your mortgage loan, including the interest rate, down payment requirements and more.
Lenders Require Minimum Credit Scores
Before knowing how great credit can save you on a mortgage, it’s important to know what mortgage lenders require. FICO credit scores, the pioneering scoring model created by Fair Isaac Corporation, range between 300 and 850.
According to Credit Karma, many lenders require a minimum credit score of 620 to qualify for a conventional mortgage loan. For a mortgage guaranteed by the Federal Housing Administration, the minimum credit score required is 580.
Knowing what your credit score is before applying for a mortgage can help you know what to expect when talking to mortgage lenders.
By federal law, consumers can get one free copy of their credit report every year by going to annualcreditreport.com. The information comes from the nation’s three biggest credit reporting companies: Experian, TransUnion and Equifax.
» Expert Tip: Looking to buy soon? Set yourself up for having your offer accepted on a home by getting preapproved for a mortgage prior to your home search.
Great Credit Usually Leads to a Better Interest Rate
The average U.S. rate for a 30-year fixed mortgage is 7.08% this week, the first time it has been above 7% since 2002, Freddie Mac (FMCC) said in a report on Thursday. To get that rate, you need stellar credit.
“Among the variables for price improvement and add-ons are the FICO score of the applicants,” said Shmuel Shayowitz, president and chief lending officer at Approved Funding in River Edge, New Jersey. “Banks will use the lower of the scores of all applicants on a mortgage to determine what the rate add-on or improvement is.”
Consider these financing scenarios for a home priced at $384,800, the U.S. median in September, and assuming a 20% down payment, which would allow homebuyers to avoid the private mortgage insurance required for Fannie Mae and Freddie Mac loans with smaller down payments.
With “excellent” credit, meaning a score of 740 to 850, the monthly payment would be $1,970 – an amount that only includes principal and interest, not other expenses like taxes and insurance, according to MSN.com’s mortgage calculator.
For a credit score ranging from 700 to 739, that payment increases to $2,065. If you own your home for 10 years, that difference will cost you $11,400. If you stay in your home for 30 years, the difference is $34,200.
If you only have a 10% down payment, which in this scenario would be $38,480, you have an additional issue before qualifying for a mortgage: You will be required, if you’re getting conventional financing, to pay private mortgage insurance, or PMI. In this example, it would be about $140 a month.
The average cost of PMI is between 0.58% to 1.86% of the mortgage amount per year, though it’s divided into monthly payments, according to the Urban Institue. Again, it’s based on credit score – the higher the credit score, the cheaper the PMI.
Great Credit Could Result in Fewer Fees
Along with a down payment, many mortgage loans include a variety of fees, including origination fees, processing fees, title fees and more. Those fees could increase for borrowers with lower credit scores.
Fannie Mae and Freddie Mac both have Loan Level Pricing Adjustments, or LLPAs, based on credit scores, Shayowitz said.
“Someone with a 699 credit score compared to a 740 credit score, at a 20% down payment, will be charged an additional 1.25% in fees, which would equate to approximately 3/8th in rate, in some cases,” he said. “Similarly, with a smaller down payment, a 679 credit score versus 740 or greater could yield a 1.25% in price (fees) adjustment.”
Great Credit Could Improve Approval Odds
Mortgage lenders also take borrowers’ credit scores under consideration when approving – or not – a loan application.
“Keeping your score as high as possible will definitely save you money and can help deter loans from not being approved,” Shayowitz said. “We are seeing more frequent examples of borrowers with scores in the range of 660 to 700 who are no longer getting their applications approved via the automated underwriting of Fannie Mae and Freddie Mac.”
How to Improve Your Credit Score to Save on a Mortgage
If your credit score is not where you want it, there are steps you can take to boost it. According to Experian, these include:
Make on-time payments.
Pay off any past-due accounts.
Reduce credit card debt.
Correct any errors on your credit report.
Avoid applying for any new credit accounts because several new inquiries in a short period can negatively impact your credit score.
Keep in mind that boosting your credit score won’t happen overnight, so if you want a higher credit score, start taking steps immediately to raise it. If you begin at the same time you start planning to buying a home, you could start to see results by the time you apply for a mortgage.
» Expert Tip: Thinking about buying a home but want to secure a good rate? Find a lender that gives you the power to lock an interest rate for an extended period so you can shop around for a home comfortably knowing that your rate is secure and won't go up. Get started here!
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For more than 20 years, Karon Warren has covered mortgage and real estate topics for such outlets as LendingTree, Investopedia, U.S. News & World Report, and others. She is a member of the American Society of Journalists & Authors, and earned her Bachelors of Arts degree in journalism from the University of Southern Mississippi. You can follow her on Twitter at @karonwarren.