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How Much Does Credit Score Affect Mortgage Rate?

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how much does credit score affect mortgage rate

Applying for a mortgage requires hard work. You must collect various documents, discuss rates and fees, and fill out application forms. Besides, you must always consider how your credit history will affect the odds of applying for a mortgage successfully.

Indeed, a mortgage is the most significant loan most people will ever get, so lenders want to ensure the debt will get repaid. As a result, creditors will demand a FICO score of 740 or even 760 before you could qualify for favorable rates.

Though everyone knows that your credit score affects approval, not everyone understands how it impacts the interest rate. Below, we reflect on the issue of why your past lending practices matter when getting a mortgage.

How Do Credit Scores Affect Mortgage Rates?

Mortgage lenders review your credit report to understand how you’ve been servicing your past debts. Your lending history will also affect the total interest you’ll pay for the mortgage type you select. In addition, special introductory rates or well-termed offers may only be available to people with high credit scores. Hence, the higher your FICO score, the better interest rates and terms you’ll get.

Moreover, a poor financial history will impact the loan-to-value ratio. Lenders use the LTV percentage to determine the risk they’re taking on secured loans. In short, the ratio measures the relationship between the loan amount and the market value of the asset securing the loan.

So, if you’re applying for a conventional loan to buy a home, creditors will require an LTV ratio of 80% or less. LTV ratios greater than 80% usually call for PMI, which can increase your payments by tens of thousands of dollars over time.

How Do Lenders Use Credit Scores?

Apart from a low DTI ratio and a solid financial history, good credit will score you the lowest mortgage rate. In short, lenders hesitate to lend money to borrowers who fail to repay on time, so they raise the rates. Creditors tend to approve loans more easily to people who have a record of on-time payments.

Lenders rely on FICO scores as an immediate and fair indication that borrowers will meet their obligations. A higher score reassures creditors that the debt will get serviced.

Your credit score is a relevant measurement of your credit risk at any given time. Besides that, lenders use income, bills, and banking relationships in the evaluation process. After considering all these segments, they reach a lending decision and define your repayment terms.

What Else Affects Your Mortgage Interest Rate?

Besides your rating, here’s what else can impact the mortgage rate:

  • Loan type: The kind of loan you intend to take is one of the most imperative factors to consider. Mortgages come in multiple forms and sizes, and APRs can vary based on the product you get. The most popular include conventional, government-insured, and fixed-rate loans.
  • Down payment: How much money you pay toward the initial home purchase can further impact the total interest rate you’ll pay. A more significant down payment can help you secure a lower interest rate because it reduces the risk to the lender.
  • Loan term and size: A 30-year fixed-rate mortgage is the most popular nowadays. Though short-term loans may have lower interest rates, the monthly payments will be more significant.
  • Location of the home: Where you live or plan to move defines mortgage rates. Check the prices on your preferred market and the ones nearby to compare the cost.

What Is the Best Credit Score for a Mortgage?

There is no need for a perfect 850 score to get the best mortgage rates. Yet, there are general credit score requirements you should meet to take out a mortgage. Future homebuyers should aim at scores 760-850 to be eligible for competitive interest rates. You can use a mortgage calculator to check your credit.

The underlying credit score requirements depend on the loan type you take out and who insures it. For instance, conventional and jumbo loans don’t get insured by the government. Hence, they often have stricter credit score requirements than VA loans.

How Much Can You Save With A Good Credit Score?

Most borrowers with credit scores above 780 succeed in getting preferential rates. As a result, they can pocket $185 in installments for any 30-year, $200,000 mortgage, unlike borrowers with scores ranging from 620 to 639. The difference is over $66,000 more in interest payments over the loan life for borrowers in the lowest credit score range. So raising your score could set aside significant cash in interest over the life of the loan.

Can You Get A Mortgage Loan With A Low Credit Score?

Having a low credit score or no lending history may mean you can’t get a mortgage unless someone is willing to assist. If you bring a co-signer who has a higher credit score could help you secure the loan.

If you have a fair credit score and plan to buy a home, your best shot is to boost your score beforehand. A housing counselor can help you along the way by walking you through your options. In addition, these financial experts can point you to relevant cost assistance programs you might qualify for.

Homebuyers looking for less stringent credit requirements may consider an FHA loan. In some cases, even credit scores as low as 500 might qualify. Still, at least a 10% down payment will be mandatory.

Boost Your Credit Score Before Applying for a Home Loan

You can use several strategies to add a few points to your credit quickly. However, if you wonder how to improve your credit score after chapter 7, take the advice below to lock in a favorable interest rate.

  • Review your credit report for any errors: If you spot an inconsistency, file a dispute with one or all of the three main credit bureaus right away.
  • Reduce your debt: Paying down debt now can help improve your DTI ratio for when you apply for a mortgage. Also, paying down credit card balances can improve your credit utilization ratio.
  • Pay your bills on time: Your payment history is a crucial aspect of your score. Mortgage lenders consider late and missed payments as indicators you cannot manage finances well.
  • Don’t open new credit cards or loans: Even minor changes to your credit can disqualify you during the approval process. In addition, any applications for new credit will stain your credit reports and could cause a lender to change their mind.
  • Don’t close old credit cards after paying them off: If you have a credit card balance you’ve already serviced, keep it open.
  • Shop around so your score doesn’t get harmed by the inquires: No matter your credit score, shopping around is critical before you apply. Check your credit, APR, terms, loan products, and services as these range across lenders.
  • Research lenders: MoneyZap works with reputable lenders that offer the best mortgage rates. You can prequalify with our partners to check the rates you’ll get. With MoneyZap, the application process is fast and reliable, while requests get processed within a short time.

Credit Score Affects Private Mortgage Insurance (PMI) Rates Too

Though it doesn’t get nearly as much coverage, your credit history can also affect the rate you pay for PMI. Your lender will require you to arrange PMI if you make a down payment of less than 20% of the property’s sale price. Private mortgage insurance ensures the lender in the event you default on the loan.

PMI companies also take your lending history into account in calculating the cost of the insurance. For example, using monthly PMI rates, you will pay a rate of 0.54% for a 95% loan with 30% coverage if you have a score of 760-850. So if you have taken $200,000, you’ll pay $1,080 per year or $90 per month besides your mortgage payment.

Then, if your score is 660-679, the rate for the same coverage will be 1.15% per year. Meaning, you’ll pay $2,300 a year or about $192 a month added to each monthly payment. That’s more than twice the cost of mortgage insurance with a higher credit score.

Final Thoughts

You can enhance your financial situation by doing your best to improve your credit history before applying. Or you can consult a housing counselor to inform you of the current criteria and terms of mortgages.

Boosting your score to purchase a house with the best mortgage rate doesn’t happen overnight. But taking the practical steps outlined above will significantly increase your FICO score over time. Only then can you get a more favorable rate and monthly payment.

Indeed, a difference of 100 points may cost or save you thousands of dollars a year. Finally, those who struggle with repayment can check the Covid-19 mortgage relief program.

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Frank is a graduate of the Master's program in Economics Sciences. He has been passionate about writing in the financial niche. He enjoys discovering new ways to improve personal wealth and sharing them with his readers. In addition, Frank likes to travel and play board games.

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