How Credit Score Impacts Your Mortgage Rate
Credit scores have a large impact not only on mortgage rates, but also the ability to qualify for a mortgage. Knowing your credit score is a good first step in the process to getting a mortgage. Small changes in your credit score could mean the difference in qualifying for a mortgage or paying thousands of dollars less in interest.
Why Lenders care about Credit Score
Credit Scores are an indication of how well a borrower meets their financial obligations. The more consistent you have been about paying bills (rent, car loans, credit cards, utilities, etc), the higher your credit score will be. A higher consistency of timely payments shows that you have been responsible with your finances and will likely continue to do so in the future. We all have a person in our lives who is constantly in a pinch or needing money. Usually, they are fast to ask for help and slow to pay you back. If that person asked for a large sum of money, you would likely be hesitant to do so. Banks are no different in this sense. If a lender sees a financial history of ignoring debts and not making timely payments, they would likely assume that this wouldn’t change by the addition of a large home mortgage.
What is a good credit score?
While a lot goes into calculating a credit score, qualifying for a mortgage is less about the exact number and more about the general range that you fall into. Lenders typically divide borrowers into the following buckets:
|Credit Score Range||Rating Category||% of Borrowers|
To qualify for a conventional mortgage, you will need to have a credit score of 620 or greater (if you have a credit score that needs improvement there are still options for you like FHA mortgages!). In order to receive the lowest interest rates, though, you will want your credit score to be at least 740. You can still get great rates below 740, lenders though will begin adding extra interest to make up for the lower credit score. The lower the credit score, the higher your interest rate will be.
How Credit Score Affects Your Rate
While lenders will give different adjustments for credit score, they will usually fall in line with Fannie Mae. Fannie Mae is the largest purchaser of conventional mortgages in the United States. Fannie Mae adds LLPAs (Loan Level Price Adjustments) or upfront fees to adjust for lower credit scores of borrowers. Lenders pass these costs to borrowers through a combination of increased interest rate (paid over time) and lender fees (paid up front).
Assuming a 10% down payment, the difference between a credit score of 745 and 645 can be quite dramatic. If a lender passes the costs on via upfront fees, the borrower with a 645 credit score will incur higher fees equal to 2.5% of the loan value. On a $300,000 loan, that is $7,500. Alternatively, if the lender was to pass on the cost via a higher rate, the borrower with the lower credit score would receive a rate around 0.75% higher. On the same $300,000 loan this would result in a higher annual payment of $1,608 annually and almost $50,000 over the 30 year life of the loan.
How Credit Score & Down Payment Affect Your Rate?
While credit score is the biggest driver of mortgage qualification and rate, your down payment or home equity also comes into play. Like a high credit score, high home equity or down payments give lenders confidence that they will be able to be made whole on their loan. Lenders reward borrowers who can put down larger down payments with lower rates, lower fees, as well as lower PMI (primary mortgage insurance). This is especially true at lower levels of down payments (less than 10%). In fact, even a small difference of 3% vs 8% down can lower your upfront fees by 0.5% ($1500 on a $300,000 loan).
Want to see how your personal mortgage rate will change for different credit score / down payment combinations? The calculator below shows exactly this. Just enter your down payment / home equity and credit score to see how your mortgage rate / upfront fees would change from the best rate.
Building a better Credit Score
It is important to understand that credit scores are not static and are not always an accurate picture of your ability to handle financial obligations. You could have a “thin” credit profile where you haven’t had the need to utilize a car loan or credit card and consequently don’t have a recurring payment credit card or loan history. You might also be suffering from an error on your credit report. Simple things like a university parking ticket or unpaid road toll could also be negatively impacting your credit score. Sometimes, we let our finances get away from us and don’t keep a close eye on our spending and payments. Many people unnecessarily carry a credit card balance that could simply be paid in full each and every month. Lowering your usage of credit and ensuring your bills are all paid in full can have strong effect on raising your credit score.
Credit Scores & Down Payments are Cliffy
Another thing to keep in mind is that lenders are not the sharpest tools in the shed and many times, penalties for lower down payments and lower credit scores are very binary and rigid. For example a downpayment of 4.9% might result in an extra interest rate of 0.125% vs a downpayment of 5.1%. Similarly, a 750 credit score might incur a 0.125% higher rate than a credit score of 770. It is important to be aware of where these interest rate cliffs occur. When you are comparing lenders, it is a good idea to run through some hypothetical scenarios for different credit scores and down payments. Many times, it is prudent to wait on a mortgage refinance / home purchase for a few months while you build up a higher down payment or work on raising your credit score.
Not all Lenders are the same!
It is very important to remember that all lenders are not created equal. When you are shopping for a mortgage, remember that all lenders have slightly different adjustments for credit scores and down payments. One lender might give their best rate to 740 and above where another only gives top rates to borrowers over 800. In a similar fashion, one lender might have a much higher penalty for a low down payment of 3% - 5%. Compare multiple lenders and ask exactly how they will adjust their best rates for your credit score and down payment. Want to start your search now? Check out the MortgageHog home page where you can instantly compare lenders and rates to find the best rate for you.