Impact of Credit Score on Your Mortgage Interest Rate.
Among many factors that will determine the mortgage interest rate your lender may ask you to pay is your credit score. However, the impact that your credit score will have on the calculation of your mortgage interest rate will depend on the type of mortgage you are applying for. I will explain this in detail down the line.
What is credit score?
Credit score is the three digit number used by credit bureaus to measure the creditworthiness of individuals based on the available information in their credit file. In most cases, lenders rely on this in order to rate the credit standing of an individual so as to determine whether to lend loan to the person or not. If they decide to lend him loan, credit score helps the lenders to measure the risk involved and this can influence the amount of loan they will grant the person and the interest rate that will apply. This applies to mortgage interest rate also. Before your credit score is arrived at, different factors are considered and each of these factors has a weight attached. Take FICO Score as an example. FICO uses the following criteria to arrive at your credit score:
- Payment history (35%)
- Amount owed (30%)
- Length of credit history (15%)
- Types of credit used (15%)
- New credit (10%)
Read Also: Tips on How to Build Good Credit History
FICO Score ranges from 300 to 850. Below is the table showing how FICO categorise credit score.
300 – 579 Very Poor
580 – 669 Fair
670 – 739 Good
740 – 799 Very Good
800 – 850 Excellent
You can see from the table that the higher your credit score; the better your rating. The more you are able to increase your credit score; the lower the mortgage interest rate you may likely get from lenders. However, it is important to note that FICO Score is not totally all encompassing. There are other things which your lenders may be interested in knowing about you such as your income, length of employment and other payments you are obligated to pay like child supports and alimony.
Effects of poor credit on your mortgage interest rate:
Now that you understand what credit score is and the importance that lenders put on it in determining your creditworthiness, let’s look at the impacts it may have on your mortgage interest rate.
High mortgage interest rate: You should not be carried away by the mortgage interest rate you may see in the adverts. Lenders usually advertise their best interest rate and this will be for only those that have excellent credit score. If you have poor credit, it is likely you will be charged high mortgage interest rate. One of the factors that can lower your credit score is when you don’t have good payment history. Payment history accounts for 35% of what goes into the computation of your credit score. So, if you fail in this area, it is not unlikely that you will have poor credit score. Lenders don’t like people with history of late payment, delinquencies and defaults. Also, if you have other debts that you owe, this might affect your debt to income ratio. With a high debt to income ratio, the lender may consider granting you a new mortgage very risky. For this reasons, they may charge you high mortgage interest rate.
Reduced mortgage loan amount: The effect that your credit score will have on you is not limited to the mortgage interest rate you will be asked to pay, it may also affect the amount that will be approved for you. If you are already having some debts, your debts to income ratio may become too high by the time your mortgage loan is added to your current debts. Lenders may assume that you will find it difficult to keep with your monthly repayments. Therefore, they may decide to reduce the amount that will be granted you.
Rejection of your mortgage loan application: If you have poor credit, you may not even bother to apply for conventional mortgage loans. The reason is that, your application will likely be rejected. Conventional mortgage lenders usually require that you have a very good or excellent credit score.
Impact of Credit Score on different types of mortgage loans
Conventional Mortgage Loan: If you plan to apply for a conventional mortgage loan, your credit score will have a great impact on your mortgage interest rate. Before you apply for this type of loan, it is better you first apply for your free credit report and review it for possible errors. If you spot any error, ensure that it is corrected before you apply for the mortgage. This may improve your credit score slightly. At times, just additional two points that such correction may add to your credit score can actually boost your chance of being considered for the mortgage. For instance, if your credit score is 798, additional two points will change your rating from being very good to excellent. You can apply for your free credit score from AnnualCreditReport.com. AnnualCreditReport.com is the only source authorised by the government for free credit reports.
FHA Loans: The requirements for FHA loans are not as strict as conventional mortgage loans. This is because FHA Loans are backed by the government. However, you may be expected to have at least credit score of 500.
VA Loans: These are available to veterans who have completed the required minimum number of years in service. This may also extend to their spouse. You can find out the requirements to see if you are qualified. VA loans do not require any minimum credit score. So, your credit score does not have anything to do here.
Tips for people with bad credit
If your credit score is bad, that does not mean you should give up on your dream of having your own home. There are certain steps you can take that can increase the chance that your mortgage loan application is considered. These steps are highlighted below:
- Increase your credit score: If your credit is bad, you can improve your credit score by ensuring that you pay your bills promptly. You should not make late payments neither should you default in your payments. If you have problems about keeping to the dates of your payments, you can set monthly payment alerts. If you are sure you will always have enough payments in your account, you can also set automatic payments. This means that your lenders or credit card issuer will debit your account automatically at your payment due dates. You need to think about this carefully so that it won’t further aggravate your credit. If you are not sure of having enough money in your account at all times, it is better not to try this. You can also boost your credit score by keeping your credit utilization below 30%. In fact, this is one of the quickest ways to boost your credit.
- Increase your down deposit: If your credit is not good enough but you have enough money to pay as down deposit, you may be able to reduce your mortgage interest rate significantly. For instance, instead of making 20% down payment, if you can increase it to say thirty or forty per cent, the lender may decide to lower your mortgage interest rate.
- Shop around: You should understand that lenders are not the same. There are lenders who may lower some flexibility. The fact that you are charged a particular mortgage interest rate by a particular lender does not mean that you will be charged the same rate elsewhere. So, if you take time to shop around, you will be able to compare rates. This can lead to lower mortgage interest rate.
Read Also: Credit Score: How to improve credit score
- Have a co-signer: This strategy works very well for people with bad credit. If you are able to find someone with very good credit who is willing to co-sign the mortgage loan for you, you will not only increase your chance of getting the loan, you will be able to get it at cheaper rate. However, someone that will co-sign you will be a person who trusts you very much. If you default in payments, his personal credit will be affected negatively. Besides, he could be held responsible for the payment of the loan.