Credit scores are those three-digit numbers that basically determine the rate on your home purchase loan. The most qualified – high credit score, low debt-to-income and solid financial history – can avail of the best a.k.a. lowest mortgage rates. And given the low rates dangling in today’s horizon, it’s important to understand how your credit score plays a role in mortgage loan pricing. »Find out if you qualify for today’s low rates.»
Breaking Down Credit Scores
Your credit score is like your risk scorecard. For lenders, the higher the credit score, the lower the risk that you’d run away from your mortgage obligation. And there are five factors that influence your credit score, with their corresponding weight, as follows:
- Payment history – 35%. This accounts for late payments, timely payments, and non-payments.
- Amounts owed – 30%. This reflects how you manage your available credit or credit utilization. Whether you pay off balances in full or pay the minimum balance.
- Length of credit history – 15%. This shows how old or new your credit accounts are, how long you’ve been using these accounts, and the average age of your accounts in all.
- Credit mix – 10%. This represents the credit accounts you hold. The more varied — credit cards, installment loans, mortgage loans, and finance company accounts – the better, according to experts.
- New credit – 10%. This reveals the credit accounts you’ve opened, as well as hard inquiries that lenders make when you apply for new credit.
Credit Scores and Mortgage Loan Pricing
Credit scores are mainly used for loan pricing, which determines the mortgage rates. FICO scores range between 300 and 850. For every credit score, there is a corresponding loan-level pricing. This is an adjustment in percentage points that lenders assign to every credit score as it moves up or down the credit score scale.
Assuming your credit score is top-notch, somewhere above 720, you’ll get a good interest rate. As your credit score goes down to say 680, there is a corresponding adjustment which makes your loan pricier as the rate is higher.
For illustrative purposes, turn to these theoretical computations on a $300,000 30-year fixed mortgage with interest rates as of Oct. 11 using this myFICO’s calculator:
- If your credit score is within 760 to 850, your APR is 3.159% and your monthly payment is $1,291 with total interest paid of $164,646.
- If your credit score is within 700 to 759, your APR is 3.381% with a monthly payment of $1,327 and total interest paid of $177,823.
- If your credit score is within 680 to 699, your APR is 3.558% with a monthly payment of $1,357 and total interest paid of $188,472.
- If your credit score is within 660 to 679, your APR is 3.772% with a monthly payment of $1,393 and total interest paid of $201,514.
- If your credit score is within 640 to 659, your APR is 4.202% with a monthly payment of $1,467 and total interest paid of $228,265.
- If your credit score is within 620 or 639, your APR is 4.748% with a monthly payment of $1,655 and total interest paid of $263,249.
Based on the above examples, the lower the credit score range, the higher the APR, which pushes the monthly payment to go up and the total interest to be paid on the loan.
Credit Scores, High or Low?
Having a low credit score doesn’t mean you’d be shut out of all mortgages. There are government-insured loans like FHA or VA that accept credit scores below 600. The impact that loan pricing has on these loans may not be as substantial as that of conventional loans which follow a loan-level pricing adjustment matrix.
However, there are instances when it’s better to lock in on the rate being offered if your credit score is already good. This is true when the mortgage loan pricing difference is not that huge. By the time you’d improved on your credit, rates may be higher and thus erase any potential savings.