How your credit score impacts mortgage loan terms
Understand your credit score—what it is and how it can affect your loan terms.
Understand your credit score—what it is and how it can affect your loan terms.
It’s no secret that credit scores play a role in mortgage qualification. Typically, a higher credit score allows a borrower to qualify for more favorable loan terms.
If you’re thinking about applying for a mortgage, it’s a good idea to understand your credit score—what it is and how it can affect your loan terms. It’s also beneficial to know common advice for prospective borrowers looking to improve their score. Let’s take a closer look!
Your credit score is essentially a number that plays a role in predicting your likelihood to repay debt. It’s calculated by one of the three credit bureaus—TransUnion, Equifax, and Experian—and based on data they’ve tracked about your credit history (your credit report is based on this data).
There are different scoring models that produce different scores, including FICO. FICO scores are commonly used by mortgage lenders. Critical factors that impact them include whether you pay your credit bills on time, how much available credit you have, and the length of your credit history.
While a credit score isn’t the only thing lenders will use to determine your creditworthiness—factors like your income, savings, total assets, debt-to-income ratio (monthly debt payments divided by monthly gross income), and down payment amount (which applies to mortgage products like conventional loans, FHA loans, and VA loans) are also considered—it’s a crucial data point they use to assess risk. In sum, your credit score provides lenders with a quick way to determine how likely you’ll repay the loan.
Before you start shopping for a mortgage, it’s best to research your credit score. Under the Fair and Accurate Credit Transactions Act (FACTA), you’re entitled to a free credit report once a year from TransUnion, Equifax, and Experian. Also, many banks and credit card companies offer a free chance to see at least one of your scores from the credit bureaus. Personal finance websites like Credit.com are good resources, too. And you can obtain your FICO score from myFICO.com.
Credit scores range from 300 (the lowest) to 850 (the highest), and the actual range depends on the scoring model that a specific score is based on. In general, a score of 670 or above is considered good, over 740 is very good, and over 800 is excellent. Scores are constantly in flux, so it’s not unusual for one to vary from month to month as a result of changes in credit utilization rate, late credit payments, new credit accounts, and other monitored factors.
Lenders may differ in what they’ll accept, but many will want a minimum score of 620 for a conventional loan. Some government-backed programs, like FHA loans and Veterans Affairs (VA) loans, accept lower scores. Overall, the higher your credit score, the more likely you are to receive favorable terms as a potential borrower.
Here are a few ways your credit score can impact the specific terms of your mortgage (can vary from lender to lender):
Qualifying for a loan: Typically, a credit score of 620 or higher is needed to qualify for a mortgage, although it might vary depending on the specific loan program. Some programs may offer less stringent qualifying criteria.
Mortgage interest rate: The higher your score, often the lower your interest rate. And a lower rate could mean that you pay less interest every month than you would with a higher rate, ultimately paying less in total interest over the life of the loan (More on this below.)
Loan amounts and down payment requirements: Although every lender will have its own criteria, borrowers with high credit scores may be eligible for larger loan amounts, smaller down payments, and a wider range of loan products to choose from.
Private mortgage insurance costs: If your down payment is less than 20% of a home’s purchase price with a conventional loan, you’ll be required to get private mortgage insurance (PMI). Lower down payments increase the risk that lenders take on and PMI insures them against losses that occur when borrowers are unable to make their loan payments. Borrowers with lower scores typically pay higher PMI premiums.
Long-term cost of borrowing: Because a credit score impacts the interest rate of the loan, your overall cost of borrowing may be dramatically impacted by your score.
Although every applicant and their credit situation is unique, these are some generally accepted, simple steps that prospective borrowers could take to help boost their credit score:
Catching up on late bills: Past due balances for certain types of debt (e.g., auto loans, student loans, credit cards) can lower credit scores. If late bills (and accompanying late fees) have accrued, such as a missed credit card payment, it could be a good idea to prioritize making those accounts current.
Not missing payment deadlines: Setting up automatic payments or urgent calendar reminders to pay bills on time is a good way to avoid past due balances.
Paying down balances: When credit cards or lines of credit have high balances, getting them down to a 30% usage rate or lower may be helpful, as higher utilization rates can lower credit scores.
Maintaining a long credit history: It might be tempting to close old accounts but keeping them open can help establish a longer credit history, which could help boost credit scores by improving the credit utilization ratio and showing a consistent track record of responsible credit management.
Limiting applications for new accounts: Applying for more credit is often counted as a negative inquiry on a credit report. So, it may be advisable to avoid adding new accounts and minimizing loan applications, if possible.
Every mortgage loan program, whether government-backed or from a private lender, has different credit score requirements and rate terms. If applying for a mortgage is in your future, it could be helpful to get a good handle on your current credit score, address any inaccuracies on your credit report, and take steps to improve your score and creditworthiness if needed.
