When we prepare to buy a home, we all want to get the best mortgage rates. But when it comes to getting the best rate, there is something even more important than saving for that down payment or getting quotes from multiple vendors. And that’s your credit score.
Getting a credit score that’s just “good enough” for you to get a mortgage can still mean tens of thousands of dollars more in interest charges over the life of your loan. So, before submitting these documents, make sure you understand how your score affects the long term cost of your home.
Why credit scores matter to mortgage rates
When it comes to determining your mortgage rate, your credit score is a critical factor.
Think about it from the point of view of the bank. They lend you money for 30 years. During this time, you will likely change jobs, face tough times, see your neighborhood change, and go through several market cycles. Your current financial situation – including down payment, assets and income – is important. But a credit score gives the bank an idea of how likely you are to make payments responsibly, even if things change.
Yet it’s not just borrowers with low credit scores that are paying the price. The difference between a good and a good score can still accumulate over the life of a loan. Assuming nothing in a mortgage application changes except the credit score, a person with a score of 680 to 699 would have a mortgage rate about 0.399 percentage points higher than a person with a rating from 760 to 850. This is a difference that may seem tiny, but it is not.
In 20 years, a person with a score of 680 to 699 will still pay more than $ 20,000 more in interest on a mortgage of $ 244,000 than a person with a high score.
So what score should you consider before applying for a home loan?
Understand which credit score matters most
A confusing aspect of credit scores for consumers is that we each has several scores. And the FICO score you get from your credit card company is probably not the same that your mortgage lender will consider. Here’s why.
Most people have information in each of the three major credit bureaus – TransUnion, Equifax, and Experian. Although they calculate all FICO credit scores, their data may be slightly different which can cause variations in the scores.
Additionally, FICO updates its rating methodology over time, resulting in many potential rating models that lenders can consider. In fact, the Consumer Financial Protection Bureau states that FICO has offered more than 60 scoring models since 2011.
Before you start worrying about pulling dozens of different credit scores, there is a saving grace. Fannie Mae and Freddie Mac, government-sponsored companies that buy many mortgages originating in the United States, set rules for the loans they purchase. So while your bank may have their own policies for particular loan types, they are likely to comply with the standards set by Fannie and Freddie in case they want to sell loans off their balance sheet. (Almost all of them do.)
Fannie and Freddie actually require much older versions of the FICO credit score. Because your credit card company score is a newer version, it may not be the same as the old version. To get a copy of the correct score, you will need to purchase it from myFICO.com.
However, I will not fail to purchase your sheet music for now.
If the score for your credit card company or free credit score websites like Credit Karma is great, the old version of your score probably is too. If your score is low, you can use the new version of your credit report to make changes to improve your score before paying for an older version.
But if your score is borderline, it may be worth buying your credit scores calculated from data from all three credit bureaus. MyFICO reports will show which scores are most widely used in mortgages so you can easily compare them.
When purchasing your FICO scores, always go for all three bureaus, unless you know which branch your lender plans to use. Otherwise, if a lender gets two scores, they will take the lower. Or in the middle, if they shoot all three. And you want to know what those scores could be.
How much can a good credit score save you?
When comparing the difference of mortgage rates, the impact may appear small. Without context, the difference between 4.55% and 4.76% seems negligible. But over 30 years, this small difference can add up.
Using the Loan savings calculator from myFICO, you can compare the interest rates, monthly payment, and total interest cost of a mortgage based on your condition and the size of your mortgage.
We used this tool to estimate the national average interest rate and the total cost of a $ 244,000 mortgage – a $ 305,000 single-family home with 20% down payment. It is equal to the current new average mortgage balance in the USA
The difference between good and excellent is significant. A person with a FICO score of 760-850 could get a 30-year fixed mortgage with an interest rate of 4.147%. This rate is more than 0.6 percentage point lower than the interest rate of 4.76% for someone with a score of 660-679.
This translates to a higher monthly mortgage payment of $ 88 per month at $ 1,274 and a total interest cost over the term of the loan of $ 214,745. That’s $ 31,905 more in interest charges than the person with a great score for the exact same house.
But the cost of interest is not the only factor. A higher interest rate not only results in a higher monthly payment, but also reduces the amount of principal you pay off when the loan begins. The average American buyer won’t stay in their home until the mortgage is paid off, on average selling their home after about ten years.
In ten years, someone with a score of 660 to 679 will have made $ 151,631 in total payments, but only $ 46,485 would go to the principal. Alternatively, a person with a score of 760-850 will have made $ 141,094 in total payments, which is more than $ 10,000 less than the person with a lower score, but will still have paid more than $ 3,800 more in principal. with these payments.
Those with a higher score will accumulate equity in their home faster and more cheaply than their peers with lower scores.
You need a great credit score for the best rates
What does it all mean? Well, before shopping for a home, you might want to take a look at your credit score. Make movements towards increase your score, like checking credit reports for errors, reducing your use of debt by paying off your credit card balance in full each month and making all of your payments on time, can help you boost your score before applying for a loan .
If you plan to put less than 20% on the purchase of your new home, you will need a 760 credit score to get the lowest PMIs and mortgage rates. But if you put down 20% or more down payment, a score of 740 is usually enough to get the best mortgage rates and loan conditions.
Even if you can’t lock in that perfect score, just a few points can push you to the next level of underwriting for slightly lower rates. And that little change can save you thousands over time.