What your credit score means for your mortgage
August 4, 2017
When it comes to buying a house, your credit score is a lot like your old SAT score. A high one is a distinct advantage. A mediocre one isn’t the end of the world, because other factors matter too. But a very low score? Well … that’s a little harder to overcome. You might need a do-over.
Here's the deal: your credit score—specifically your FICO score—is basically an assessment of how you handle debt. It tells lenders how dependable you’ll be at paying back a loan. That means your score can determine whether you’ll qualify for a mortgage at all, as well as which loan options might be available to you. And once you do qualify, it usually affects your interest rate, which determines how much you’ll pay over the life of your loan. Which for most of us means the next 30 years. Lastly, it can also affect the fees associated with your loan.
So let’s unpack the full impact of your credit score—that number lurking in the background of every consumer’s life.
Your mortgage-worthiness (the Cliffs Notes version)
Your FICO score will directly affect your mortgage in four ways:
- Whether you’ll qualify for a loan at all
- Your loan options
- What your interest rate will be
- Extra loan fees you might pay
Before we dig deeper
Here’s a rough breakdown of what your score will probably mean:
750+ You should qualify for a variety of mortgages, with the best interest rates and the lowest fees.
680+ You’re likely to qualify, and with a good interest rate and standard fees.
600 – 680 You might qualify, but you’ll probably have fewer loan options and pay a higher interest rate and fees.
350 – 599 You probably won't qualify for a mortgage, except in some special cases.
Read on for the details. But keep in mind: lenders don't look at your credit score in isolation. There are three other important credit factors, so all is not lost if yours is kind of... meh.
Different scores, different mortgage options
Where you fall on the credit score spectrum will affect what type of loan you can get. This overview can’t cover all the loan products and programs out there. Some are state-specific. To make sure you’re aware of all the options that might work for your unique situation, it’s best to consult a local homeownership advisor.
Excellent credit score? Look into a conventional mortgage
Conventional mortgage loans are those that aren’t government-insured or guaranteed. They’re made strictly by private lenders, like banks and credit unions.
- Major plus: Conventional loans tend to have the best interest rates.
- Major caveat: To qualify, you usually also need excellent overall credit, steady employment, and a pretty good income. And remember that if your down payment is less than 20%, you’ll probably need to buy private mortgage insurance (PMI). Your lender will definitely inform you if that's the case.
Medium or low credit score? Look into a government-backed loan
Government-backed loans are very popular with first-time homebuyers because they make buying easier financially, including for homebuyers whose credit score is south of sparkly. That’s a lot of us: simply being younger lowers your credit score, since you haven’t had as much time to build up a credit history.
- Major plus: More flexible standards for your credit score and overall credit. In addition, government-backed loans often have a lower or even no down payment.
- Major caveat: The government sets its own minimum credit score standards, but lenders are free to impose stricter ones and often do. Plus, some have income or other limits that might count you out.
Here are the main government-backed loans. Again, we’re focusing on credit scores, but remember that the various loans have different requirements, and different benefits too. As we suggested earlier, the best way to kick-start start your research is probably a talk with a homeownership advisor, who will be up-to-date on all of them.
- Federal Housing Administration (FHA) loan: If your credit score is 580 or better, your down payment can be as little as 3.5 percent. You can search for an FHA lender at HUD.gov
- Fannie Mae’s HomeReady loan: You’ll need a credit score of 620 or higher, depending on factors like your debt-to-income ratio. Your down payment can be as little as 3 percent. Here’s a good Zillow article on this one.
- USDA rural development (RD) loan: This loan is only available to lower-income homebuyers who want to live in designated rural areas, which includes towns with populations under 20,000. It requires a credit score of at least 640. It’s one of the only zero-down-payment options out there. Learn more at USDA.gov.
- Veterans Administration (VA) loan: Are you or a family member in the armed services? Explore this loan. The VA doesn’t enforce a minimum credit score, but most lenders want to see at least 620. Big plus: unlike other loans, this one doesn’t base your interest rate on your credit score, so a low score won’t saddle you with a high one. Visit VA.gov.
Your interest rate: small number, huge impact
With most loan options, your credit score is a big driver of the interest rate you’ll end up paying on your mortgage. Not to mention on loans for other major purchases, like a car. It works like a see-saw: when your credit score goes up, your interest rate comes down, and of course vice versa. A good guideline is that you’ll take a hit every 20 points or so.
The impact on your monthly payment can be significant. The impact over the life of the loan can be jaw-dropping!
Let’s say, for example, you want to borrow $300,000 in the form of the typical fixed-rate 30-year mortgage. If your FICO score is 780, the lender might give you a rate of 3.5 percent. Your monthly payment would be about $1,347. If your score is more average, say 680, you might get a rate of 3.75 percent, for a monthly payment of $1,389.
That’s another $42 a month because of that quarter-percent rate difference. Maybe that doesn’t sound so bad. But fasten your seatbelt for how much extra you’ll pay over the life of the loan: more than $15,000! That’s a lot of money you could have put into the house itself or stashed in an IRA. As you can see, it pays to take charge of your credit score.
Heads-up on some hidden fees
Little-known fact about conventional loans: your credit score can also affect various industry-standard “risk-based” fees, some of which lenders don’t even think to explain. The two main ones are LLPAs (loan-level pricing adjustment) and G-fees (guaranteed fees).
Such “add-ons” in turn are one reason why the interest rate a lender quotes you might be mysteriously different from what you see advertised. In other cases, you’ll be asked to pay extra at closing.
While these fees can have a significant impact on your bottom line, the government-backed loans that don’t charge them have their own fees and restrictions. Confusing, right? At the risk of sounding like a broken record … this is another case where a homeownership advisor will be able to help you weigh the variables and settle on the mortgage that works best for you.
So should you boost your credit score before buying?
Some score fixes can be pretty fast, but others take real work and time. If your credit score is on the low side, should you work on raising it before you buy, or go ahead and buy now? There’s no easy answer, because it’s so dependent on individual and market circumstances that can offset a lower credit score. A homeownership advisor can help you think it through.
In the meantime, here are some questions to ask yourself:
- Can you come up with a larger down payment? That can offset a lower score.
- Or should you use that money to improve your credit score by paying down debt?
- Are rents or home prices rising fast in your area? Getting into the market now might save more than your credit score will cost you.
- Are interest rates in general going up fast?
- Have you found a house that’s can’t-pass-up perfect?
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