October 10th, 2016 5:05 AM by Jackie A. Graves
Without a high credit score, you won’t qualify
for the best mortgage rates available, which could mean you’ll end up paying
more money over the term of your mortgage. Even with rates at historic lows
right now, the difference between 3.5% and 3.75% can add up, especially if
you’re applying for a 30-year fixed-rate mortgage.
Why does your credit score matter to lenders?
Along with a low debt-to-income
ratio and a strong financial history, a high credit score gets
you a low mortgage rate. But why?
You’d probably be hesitant to lend money to a
friend who usually takes forever to pay you back — or doesn’t pay you back at
all. Lenders feel the same way when it comes to mortgages. They want to lend to
people who have a record of on-time payments to creditors.
“If somebody has a high credit score, what
that shows us is that they’ve been good on meeting their obligations, whether
it be credit cards, car loans or other home loans in the past,” says Brian
Hoovler, a loan production partner with People’s Home Equity in San Francisco.
“It means we’re more likely to want to give you a loan, because we know you’re
going to pay us back.”
Your credit score is calculated most often
with the FICO scoring
model, and is derived from the information on your credit
reports, which are compiled by credit reporting companies. Your reports
include a history of your payment habits with borrowed money.
Your credit score is “one of the most
important parts to qualify,” says Michelle Chmelar, vice president of
mortgage lending with Guaranteed Rate in New York. “But it is a part. You have
to have the whole package: income, sufficient assets and credit.”
Best scores for conventional loans
“Typically, when you have a score of 700-plus,
you’ll get a pretty good interest rate,” says David Lin, a former director of
risk management for consumer credit at Barclays and Citibank. He says that
while you can still qualify for certain loans if your score is under 680, the
700s are where you want to aim in order to pay the lowest rates.
If you’re at the top of the scale, say 720 or above,
you’re in the territory known as excellent. As you move down toward 700, your
score is considered good. Once you get to 680, you’re heading toward average,
and if you’re closer to 640, you might have trouble getting a conventional
mortgage from a bank or online lender, Chmelar says.
The lending industry carves up the credit
score scale into 20-point increments and adjusts the rates it offers borrowers
each time a credit score moves up or down by about 20 points. For instance, if
your score drops to 740 from 760, you’re likely to see a small bump up in the
rate you’ll be offered. In the industry, this is called “loan-level pricing,”
and every time you go down a level, there’s an increase in costs, according to
“If you have a score of 760 or above,” Hoovler
says, “you’re pretty much golden. From there down, every 20 points you’ll start
seeing small hits here and there.”
Chmelar offers up a scenario to illustrate a
100-point difference in credit scores:
A borrower with a 20% down payment is applying
for a 30-year, fixed-rate, $300,000 loan to purchase a single-family home
in Westchester County, New York. She has a 780 FICO credit score, which gets
her a 3.5% rate. Out of pocket, that’s $1,347 a month.
If the borrower’s score dropped by 100 points
to 680, her rate would bump up to 3.75%, and her monthly payments would
increase to $1,389, an extra $42 a month, or $500 per year. “That’s a lot of
fun at Starbucks,” Chmelar says.
The impact of the difference in the rates may
not seem significant at first, but added up over years, you could end up paying
a lot. For example, Chmelar’s 100-point-drop scenario has the borrower paying
an additional $15,120 over a 30-year period.
If your score is already good, however, you
should consider taking the rate you qualify for. “The difference between a
710 and a 750 score is not so huge that you should wait to raise it,” Hoovler
says. If mortgage rates go up while you’re fine-tuning your credit score, “the
increase is in all likelihood going to offset any benefit the higher credit
score gives you.”
Other loan types
With conventional loans — those backed by
Fannie Mae and Freddie Mac — a lot of focus is put on your credit score,
according to Dan Keller, a mortgage advisor at New American Funding in Seattle.
Government-insured FHA and VA mortgages, on
the other hand, may accept a score as low as 580. The impact of that lower
score won’t be as substantial as it would be with a conventional loan, Keller
notes. He says to get the best interest rate with an FHA or VA loan, the focus
isn’t on a 760 score as it is with conventional loans — it’s on 700+.
So, there’s some leniency when it comes to
credit scores and underwriting guidelines with government loans. But the loan
fees are more expensive: You’ll have to pay private mortgage insurance, as well
as an upfront and an annual mortgage insurance premium.
Jumbo loans — loans that exceed conforming
limits imposed by Fannie and Freddie — have stricter credit
score requirements. “Ideally you’d want to be at 760 or above for a jumbo
loan,” Hoovler says.
But those credit score guidelines don’t tell
the whole story. Most lenders have what are known in the industry as “overlays,”
which are extra requirements or standards that allow them to require higher
credit scores as a precaution, regardless of loan type.
Hoovler says these overlays vary widely from
company to company, and if a borrower fails to meet overlay requirements with
one lender, it doesn’t mean a mortgage is out of reach. “Just because one
lender says you’re not qualified doesn’t mean you can’t get a loan,” he advises. “It
just means you may have to do some more digging to find somebody who’s willing
to work either with your credit situation as is, or is willing to help you find
someone who can put you into a better credit situation.”
How to improve your credit score
Here are some of the best ways to improve your
“The number one way to improve your credit
score is to look at your balance-to-limit ratio,” Keller says. “For example, if
you had a credit card with a $10,000 limit, and I pull your credit and you’ve
got $8,000 charged on that and your credit score is a 726, if I can get you to
pay down that credit card to 30% or less — down to $3,000 — your credit score
would jump substantially.”
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