Your credit score plays a huge role in getting a mortgage. That is because it is a variable that helps the lender determine how likely you will pay off your loan on a timely basis. Credit bureaus evaluate people’s credit worthiness using a FICO score. The higher the score the better the borrower’s credit.
Impact of Credit Score on Mortgage
The mortgage rate charged to a borrower depends on their credit score. There is an inverse relationship between credit score and interest rate changed. The higher the score the lower the rate and the lower the score, the higher the rate.
Therefore, it is not unusual to see two separate buyers approved by a lender, but charged different interest rates based on their credit scores. This is true even if they have the same income and purchase the same priced home.
You could save thousands of dollars over the life of a loan by improving your credit score by just a few points. A $350,000 mortgage at 3.5% has a principal and interest payment of $1,571.66. By improving your credit score to qualify for a 3% rate, it would save $96.04 a month.
Over the life of the mortgage, that would save $34,575 in interest. Improving your credit score to shave 0.25% off the rate would make it worthwhile.
Credit Score Components
The percentage of total credit used compared to the total credit available is your credit utilization. If you have a $2,500 balance on a credit card with $10,000 available credit, your utilization rate is 25%. Ideally, it should be 10% or below. This ratio accounts for 30% of a person’s FICO score.
You calculate credit utilization using the balance on the monthly statement. Therefore, paying it off in full every month could still result in a high CU score. Some credit counselors suggest paying down the balance before the end of month statement comes out. A trusted mortgage professional can make specific recommendations like how to improve your credit utilization.
When you credit limits are lowered, your credit score suffers. You may have the same monthly outstanding balance you have had for years. However, it now becomes a larger percentage of your available credit and your score goes down. In the example used earlier, assume that the available credit is now $5,000 and your balance is $2,500, the credit utilization is now 50%.
Payment history is the largest contributor and counts for 35% of an individual’s FICO score. It is an indication of your likelihood of paying on time and as agreed for your debt. This is especially true for mortgages, credit cards, student and car loans, among others.
A surprise to some borrowers is to find out that even if they never actually paid a late fee because of a grace period, their score was still dinged because it was not paid on time of the actual due date.
Foreclosures, deeds in lieu of foreclosure and bankruptcies will affect a borrowers payment history as long as they appear on the credit report.
Check Your Credit!
Americans are entitled to a free annual credit report by law from the major credit companies: Experian, TransUnion and Equifax. Visit AnnualCreditReport.com for these federally authorized reports. During the Covid-19 pandemic, they are offering free weekly reports.
Even if you are not buying a home or getting a mortgage currently, it is a good routine to check your credit report periodically. This will allow you to discover signs of identity theft early.