May 9th, 2020 12:57 PM by Jackie A. Graves
Right now, a high credit score can mean getting up to 83 basis
points shaved off your mortgage interest rate compared
to people with lower scores. It’s a gap that is widening as the pandemic grinds
on and credit standards for borrowers tighten.
A recent report by the Urban Institute shows that borrowers with
scores above 720 are getting mortgage rates 78 basis points lower than folks
with scores below 660. In the nonbank space, the spread is wider, as high-credit
scores can knock off up to 83 basis points from mortgage rates.
Those basis points add up fast on a 30-year fixed-rate mortgage.
If you borrow $300,000 at 3.5 percent, you’ll pay $1,347 a month and total
interest of $184,968. But the same loan at 4.3 percent means a total interest
of $234,461. That’s a difference of $49,493.
Lenders have always reserved the lowest rates for borrowers with
high FICO scores, but the gap has gotten wider since the pandemic. This
behavior is typical during downturns, says Michael Neal, senior research
associate at the Urban Institute.
“We definitely saw that wide spread during the great recession.
In 2008, the spread between low and high credit scores peaked at 62 basis
points in 2008,” Neal says.
Not only did the housing crisis cue credit-tightening but it
also prompted lenders to stop offering certain products, which we’re also
seeing now. HELOCs, for example, which
are loans collateralized by the borrower’s house, are starting to vanish from
the market as lenders reduce their risk.
“Banks are also looking at cash-out refis and tightening the
availability of those products. They don’t want to make risky loans,” says
Ralph McLaughlin, chief economist at Haus. “Wells Fargo, as an example, wasn’t
going to process jumbo refis unless the applicant had $250,000 in cash with
Wells also announced this week it is suspending new applications
for home equity lines of credit, following the lead of mortgage giant Chase
Lenders are in a protective mode as unemployment numbers
skyrocket. One way they can shield themselves from borrowers defaulting on
their loans is to apply a credit overlay, which is an increase in standards
beyond what’s required from government or GSE guidelines.
“Typically a loan servicer needs a loan to perform for at least
three years so they can break even,” says Kevin Martini, senior mortgage
strategist at Martini Mortgage Group at Benchmark Mortgage. “With the spike in
unemployment, servicers fear they will not be able to service the loan long
enough to break even because the borrower might lose their job, they can no
longer pay the mortgage and the property becomes distressed.”
Since the credit score is one
can suss out risk, they’re charging more for riskier borrowers in order to
protect themselves if the loan runs into problems.
“The mortgage rate spread is saying you can still get a mortgage
but you’ll have to pay a higher price for it. The next step is we’re going to
restrict you from getting a mortgage if your credit score falls below a certain
number,” Neal says.
Making loans more expensive and harder
to get will
have an effect on millions of borrowers.
“This is going to have an effect on African-American and
Hispanic borrowers — people who disproportionately have not been able to
benefit from homeownership because they have lower FICO scores,” Neal says.
This will also impact first-time borrowers who tend to be
younger, earn less and have lower credit scores than their more affluent peers.
“We see a very strong correlation between credit scores and
higher incomes. Borrowers with lower incomes, first-time buyers and younger
borrowers also happen to be a bigger share of the job segment impacted by
COVID-19. This will impact them for at least the next three to six
months,” McLaughlin says.
Equity-rich homeowners can also be penalized during the pandemic
if credit standards continue to rise, making it tougher to qualify for cash-out
“Homebuyers who have built up equity aren’t able to tap into it
or will have to tap into it at a very high rate,” Neal says. “People who didn’t
mimic the go-go years of housing refi and thus have a lot of equity won’t be
able to access it now when they need it.”
Credit availability will stay where it’s at or even shrink if
the economy continues to take hits from high unemployment, shuttered businesses
and lower consumer spending.
“Whether the recovery will be ‘V-shaped’ or will it be
‘U-shaped’ is the thing to keep on the radar — once the servicers have the
certainty that defaults are not a reality, I think it will go back to business
as usual,” Martini says.
Borrowers who want to get a mortgage but have credit scores
below 700 might want to wait on the sidelines while they improve their credit
or they could face higher mortgage rates.
If you want to get a mortgage now with a sub-700 FICO
score, shop around, says Casey
Daneker, real estate agent at Keller Williams Realty, Inc.
“Yes, mortgage companies are tightening up their requirements
for loans. Requirements for credits scores have already changed and some
smaller lending companies are removing certain loans altogether. Now is the
time to shop around and see who can provide you with the best options,” Daneker
For borrowers who can wait, this is a good time to work on your
credit score. The higher your score, the lower your loan costs will be.
Mortgage lenders typically look at credit scores from all three reporting
agencies: Equifax, Experian, and TransUnion, and will use the middle
score in determining your loan terms.
The first step in improving your score is to analyze what’s
holding your score down, says Adrian Nazari, chief executive officer at Credit
Federal regulations permit consumers to get one free copy of your
credit report every 12 months from each of the three nationwide credit
reporting bureaus: Equifax, Experian and TransUnion. Once you get your reports,
you can see how different categories are affecting your score, including
payment history, debt utilization, length of credit history, types of credit,
and inquiries for new credit.
“Even a single error can lower your credit score, depending on
what type of error it is, so the first step in fixing your credit is to
discover and clear up any reporting errors,” Nazari says. “You can dispute an
error with the credit bureau that issued the report, or you can dispute it with
the creditor who reported the data in the first place.”
Once you clear up any errors on your report, you can
systematically begin fixing some of the negative events.
Nazari gives insight into what mortgage lenders are looking for,
what will impact your score the most and how borrowers can strategically attack
their credit score to raise it as fast as possible.
In the newest credit scoring models, paid collections are
ignored but unpaid collections hurt your score. Recent collections hurt the
New data is usually reported once a month, but some lenders will
report it every 45 days.
Since payment history is the single biggest factor affecting
your credit score, establish a perfect payment record for at least six months
and preferably for two years or longer.
A high debt-to-income ratio is the biggest red flag in a new
mortgage application. Even though it might not be possible for you to pay off
all debt before applying for your home loan, you should bring it down as low as
possible. That’s because mortgage lenders will examine your debt-to-income
ratio, or DTI, to determine whether you will be able to afford your new
It may seem counterintuitive to leave credit card accounts open,
especially after you pay them off, but that’s what you should do. This is
particularly true if you still have debt on one or more other cards. It goes
back to your credit utilization ratio. Remember, the less you owe in comparison
to the total amount of credit available to you, the better your utilization
ratio will be.
Too many inquiries may show that you’re desperate for credit or
that you’re at risk for financially overextending yourself. Don’t apply for
credit unless you need it. And definitely don’t apply in the six months
preceding your loan application. However, you can shop for mortgage rates
without worrying about multiple inquiries because the only way to compare loan
offers is to apply with more than one lender.
Becoming an authorized user on someone else’s account, such as a
parent or sibling means that you will automatically benefit from the age of
their credit history. While the primary cardholder is still responsible for
making the payments, you get to reap the benefits of building credit.
You can use a credit monitoring service to catch any credit
reporting errors and avoid surprises when you apply for a mortgage.
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