When it comes time to buy your first home, the biggest challenge you will likely face- othe than trying to choose the right home for your family- if going to be applying for a mortgage loan. This is a process thousands of people go through every day across the country and some have good experiences and others have less than great experiences securing a mortgage loan. If you are in the middle of this process, you may be surprised to learn that your credit score has the most meaningful impact on the rates you’ll be offered. Typically, the higher your score, the lower the interest rates you’ll be offered by lenders. This means that with a good credit score you may get a $50,000 loan at 16% interest but with a poor credit score you may only get a $30,000 loan at that same rate, or you may get a $50,000 loan but at a much higher interest rate.
“Credit scores are enormously influential in the mortgage process and they have been since the [Federal Housing Finance Agency] essentially forced the mortgage world to start using them in the late 90s,” says John Ulzheimer, author of “The Smart Consumer’s Guide to Good Credit.” Ulzheimer says credit scores are “as important as a solid appraisal and having sufficient income” (Bankrate). Most credit scores in the US are based on the Fair Isaac Corporation (FICO) model, which grades consumers on a 300- to 850-point range. Those with a good track record of paying back loans and not missing payments will have a higher score and these are the people who are usually looked on most favorably by banks and lenders. Generally, a score of around 750 or higher on the FICO scale is considered an excellent score.
Boost your score to improve your mortgage rates
If your credit score isn’t great, it is not the end of the world. There are things you can do to start bringing that score up and improving your status with lenders. Most importantly, get a copy of your credit report and review it carefully for any errors. Sometimes simply correcting mistakes can help improve your score. Also make sure you make all payments on time and whenever possible, pay more than the minimum due so you can work on paying off debt rather than just maintaining the interest rate payments each month. As you start shopping around for a mortgage, it is best if you hold off on opening any new lines of credit. “With a lot of inquiries, the combined effect could be enough to bring your score down. Even a small drop in your credit score could have an impact on the rates you’re qualified for.”
If you decide to do some rate-shopping, try to compare lenders all within 30 days of when you think you’re ready to pull the trigger on a loan. If you want to check 5 different lenders try to review them all within that month’s time. According to FICO, any mortgage or auto loan inquiries made within 30 days of when they generate a credit report for a lender are not generally counted as negative marks against the credit score.
Why does your credit score matter to lenders?
Along with a low debt-to-income ratio and a strong financial history, you’ll need a high credit score for the lowest mortgage rates. Why?
“You’d probably hesitate 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 about 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” (NerdWallet).
Small steps build up over time and make all the difference
The important thing to remember is that if you score is not the best now, you can start working on improving it. Small steps and changes to how you mange your debt and send your money can really help boot those score numbers and help you get an approval from the lender for your mortgage loan!