How Does Credit Score Affect Mortgage Rates?
When you’re looking to take out a mortgage, there are many questions you’re going to have, especially if you’re a first time buyer. You may be asking yourself: How does my credit score affect my mortgage rate? What is a good credit score to buy a house? What can I do to improve my loan options? All of these questions are crucial to understanding the borrowing process, improving your chances of getting a loan approved and ensuring you get the best rates and lowest costs possible.
What is a credit score?
Your credit score is a numerical rating assessed by one of the national credit bureaus that give lenders a snapshot of your financial borrowing history. In other words, these credit companies look at your past borrowing habits, how much debt you have, if you make payments on time and any other factors and then gauge how reliable you are when it comes to paying back borrowed money.
The more reliable credit bureaus think you are, the higher your score will be. If you have late payments, bankruptcies or other past credit issues, you will have a lower score. If you just haven’t borrowed much money in the past, you will have a lower score because the credit bureaus have little to no information to make a proper assessment. The system is not perfect, but credit scores are utilized industry-wide by lenders for loan approvals and interest rates.
What is a good credit score to buy a house?
While the ultimate decision is up to the individual lender on approval, there are some general industry standards across the board.
“An individual’s credit score is critical to qualifying for a mortgage as it provides a track record and quantifiable data correlation to the individual’s ability to pay its debts on time. Generally, a 640 or better score is required to qualify for a conventional loan with a 580 or better credit score to qualify for FHA financing,” David DiNatale Esq., president of Capital Funding Financial LLC, said.
“As counsel for a family office fund and mortgage company, we use credit scores as a factor to assess the borrower’s ability to pay the loan on time. The higher the score, the less risk we assess with the loan and allow for a lower down payment. The lower the score, the more risk we assess with the loan and require a higher down payment to offset that risk,” DiNatale said.
How does my credit score affect my mortgage rate?
As DiNatale states, your credit score lets lenders know how much risk they are taking on by extending financing to you for your home purchase. A basic principle of finance says that the riskier the investment, the more return you should be getting. If you’re someone who has no history of good borrowing practices or you have some mistakes from your past on your credit report, the lender will be taking a bigger risk approving you for a home loan.
This greater risk means the lender is going to need to see a bigger return on their investment. Since lenders profit from the interest you pay on your loan, you can expect to see a higher mortgage interest rate with a lower credit score.
Why your credit score matters to lenders
You may be the most reliable person in the world and you may have corrected your past financial mistakes, but banks, credit unions and lenders don’t know you personally. Lenders don’t have intimate knowledge of your intentions, habits and new financial practices. One of the few tools they have to gauge your creditworthiness is your credit score.
While you may or may not agree with the picture your credit score paints, you do need to understand lenders have to work with what’s available. If lenders ignored credit scores and just took people’s word for their reliability, most companies would not be in business for very long.
Mortgage options for less than good credit
If you have less than good credit, it means you are a riskier investment for lenders. However, it does not mean they won’t do business with you. There are mortgage options available for those with less than stellar credit or for people who lack an extensive credit history. Federal Housing Administration (FHA) loans are available for people with lower credit scores. As these loans are insured by the government, lenders are more likely to extend credit to buyers with lower credit scores.
Ways to improve your credit score
Searching for a lender that will work with low credit scores is only one way to approach the equation. Buyers who are not in a time crunch can focus on improving their credit scores, which will open up new possibilities for loan approval and the potential for better interest rates.
To improve your credit score, start by getting copies of your report from the major credit bureaus. From there, look to see if there are any errors or incorrect information to dispute. Even one incorrect late payment can significantly lower your score. You’ll then want to look at any areas of impact you can work on. This could include on time payments, outstanding debt, the number of open accounts and overall credit history. Small changes and demonstrations of good borrowing behavior can have a big impact on your overall score.