How Credit Scores Impact Your Mortgage Rate

When you’re thinking about buying a home, one of the most critical factors that will come up is your credit score. Whether you’re aware of it or not, your credit score can have a huge impact on whether or not you get approved for a mortgage, what kind of interest rates you are offered, and how much you’ll end up paying in the long run.

In this guide, we’re going to break down what a credit score is, how it affects your mortgage options, and what you can do to improve your score to get a better deal.

What’s a Credit Score Anyway?

A credit score is a number that reflects how well you’ve handled debt in the past. It’s like a report card for your financial habits. It is used by lenders, including mortgage lenders, to assess how likely someone is to repay their debt on time. The score is based on several key factors in an individual’s credit report, such as the amount of debt, payment history, length of credit history, types of credit used, and recent inquiries for new credit.

The most commonly used credit scores in the U.S. are FICO® scores, which range from 300 to 850. Here’s how they generally break down:

• Excellent (780-850): Borrowers with excellent credit are likely to be offered the best interest rates and terms.

• Good (700-779): These borrowers are generally offered favorable mortgage terms.

• Fair (660-699): Those with fair credit may still qualify for a mortgage, but they may face higher interest rates and less favorable terms.

• Poor (620-659): Borrowers with poor credit may struggle to qualify for a mortgage or may face very high interest rates.

• Very Poor (300-619): It is extremely difficult for individuals with very poor credit to qualify for a mortgage, and if they do, they will pay a much higher interest rate.

For detailed information on how your FICO® credit score is calculated, visit out Credit Scores Learning Center.

How Credit Scores Impact Your Mortgage Approval

Mortgage lenders use credit scores to assess the risk of lending money to a borrower. A higher credit score indicates that the borrower has demonstrated an ability to manage debt responsibly, and as a result, they are less likely to default on the mortgage. Conversely, a lower credit score suggests that the borrower has a history of financial mismanagement, making them a higher-risk borrower.

The most significant ways in which credit scores influence mortgage eligibility are:

1. Loan Approval or Rejection

Lenders typically have minimum credit score requirements for different types of loans. For example, many conventional loans require a minimum score of 620. Some government-backed loans, like FHA loans, might accept lower scores (as low as 580) if you’re putting down a bigger down payment.

2. Down Payment Requirements

If your credit score isn’t so great, lenders might ask you to put down a larger down payment. The bigger the down payment, the less of a risk the lender takes on. So, if your score is on the lower end, they might want to see a 10% or 20% down payment instead of the typical 3% or 5% down.

3. What Kind of Loan You Can Get

Different types of loans have different credit score requirements. FHA loans are generally easier to qualify for, even with a lower credit score. Conventional loans, on the other hand, often have stricter requirements. A lower credit score might limit your options or force you into a loan with higher interest rates.

4. Interest Rates

This is a big one. Your credit score has a direct impact on the interest rate you’ll be offered. The higher your score, the lower your rate will likely be. A lower interest rate means you’ll pay less over the life of the loan. For example, someone with an excellent score of 780 might get an interest rate of 5.5%, while someone with a lower score of 650 might end up paying 6.5% or more. Over the term of a 30-year mortgage, that can mean tens of thousands of dollars more in interest.

How Credit Scores Are Calculated

There are five main factors that make up your credit score, and each one plays a different role.

Let’s break them down:

1. Payment History (35%) Your payment history is the most important factor. Lenders want to know if you’ve paid your bills on time. Missed payments, defaults, or bankruptcies can really hurt your score.

   
   

2. Credit Utilization (30%) This is how much of your available credit you’re using. For example, if you have a credit card with a $10,000 limit, and you’ve charged $8,000 on it, your credit utilization is 80%. A good rule of thumb is to keep your credit utilization below 30%. The lower, the better.

   
   

3. Length of Credit History (15%) How long you’ve had credit matters. A longer history of managing credit responsibly helps boost your score. So, keeping old credit cards open (even if you don’t use them) can help.

   
   

4. Types of Credit (10%) Lenders like to see that you can manage different types of credit, such as credit cards, installment loans (like a car loan), and mortgages. Having a mix of credit types can help your score.

   
   

5. New Credit (10%) Opening several new credit accounts in a short period of time can lower your score. Lenders see this as a sign you might be taking on too much debt at once. So, it’s a good idea to hold off on applying for new credit cards or loans when you’re thinking about getting a mortgage.

How Credit Scores Affect Other Mortgage Terms

Your credit score doesn’t just impact your ability to get a mortgage — it also affects how much you’ll pay for it. Let’s take a look at some of the extra costs your credit score can influence.

1. Private Mortgage Insurance (PMI)

If you’re putting down less than 20% for a conventional loan, you’ll have to pay for private mortgage insurance (PMI). If your credit score is lower, PMI premiums may be higher, meaning more money out of your pocket every month.

2. Closing Costs

In some cases, borrowers with lower credit scores might face higher fees when closing on a mortgage. These could include higher origination fees or discount points. Essentially, you might pay more upfront if your credit isn’t in great shape.

3. Loan Terms

Lenders may be more likely to offer shorter loan terms (like 15 years instead of 30 years) to people with higher credit scores. A shorter term means higher monthly payments but lower overall costs (since you’ll pay less interest). If your credit score is lower, you might be stuck with a longer loan term, which means lower monthly payments, but more interest paid in the long run.

How to Improve Your Credit Score for a Better Mortgage Deal

Knowing that your credit score has a big impact on your mortgage, you might want to work on improving it before applying for a loan. Here are some simple ways to boost your credit score:

1. Pay Your Bills On Time This might seem obvious, but it’s crucial. On-time payments are the biggest factor in your credit score. Set up reminders or automatic payments to ensure you never miss a due date.

   
   

2. Pay Down Debt If you have credit card debt or loans, try to pay them down, especially high-interest debt. Reducing your debt will help lower your credit utilization, which in turn can boost your score.

   
   

3. Check Your Credit Report for Errors Sometimes, credit reports have errors. Maybe an account is listed as overdue when it’s not, or there’s incorrect information about your payment history. You can request a free credit report every year, so be sure to check for errors and dispute them if necessary.

   
   

4. Avoid Opening New Credit Accounts Don’t apply for new credit cards or loans right before you apply for a mortgage. Each credit inquiry can ding your score a little, so it’s better to hold off on new credit applications.

   
   

5. Keep Old Accounts Open If you have old credit cards you’re not using, don’t close them. The length of your credit history is a factor in your score, so keeping these accounts open can help.

Final Thoughts on How Credit Scores Impact Your Mortgage Rate

Your credit score plays a huge role in the mortgage process. It affects whether you’ll get approved, what type of loan you can get, what your interest rate will be, and how much your mortgage will cost over time. The better your credit score, the better deal you’ll likely get. So, before you start house hunting, it’s a good idea to check your score and work on improving it if needed.

By keeping your payments on time, paying down debt, and monitoring your credit, you’ll be in a good position to secure a mortgage that works for you. Remember, the higher your score, the lower your costs — and who doesn’t want to save a little extra cash when buying a home?

How I Can Help You

When it comes time to purchase a home or refinance an existing loan, I want to help you! Hopefully articles like this give you good information and a better understanding of the mortgage world, but let me use my experience and expertise to help you with your particular situation.

I tell my clients and referral partners that a mortgage transaction starts with a simple conversation. Let’s talk about your financial situation, budget, and goals so that I can help you determine the best solution for you. During a 10-minute informal conversation, we can get you on the right path as it relates to a home purchase or mortgage refinance.