Most people come to a point in their lives when they decide to stop paying for rent or living with their parents; they decide to become home owners. Qualifying for a mortgage loan and receiving the best rates depends heavily on your credit score. Lenders will decide whether to lend you money or not, what type of mortgage you can apply for, and what your interest rates and fees will be based on your credit report. Understanding how your credit score affects a mortgage loan can save you thousands of dollars over the life of the loan.
How is Credit Score Determined?
The Fair Isaac Corporation (FICO) score is the most widely used scoring method. Some lenders may use other scoring methods, but FICO is the most popular. The FICO scale ranges from 300 to 850, with most people being in the 600 to 800 range. A credit score of 720 and above is considered a good credit score and it will be the most advantageous when shopping for a mortgage loan.
There are three major credit bureaus in the United States, Equifax, Experian, and TransUnion, and they each use a different scoring method: Equifax uses the BEACON method, Experian uses the Fair Isaac Risk Model, and TransUnion uses EMPIRICA scoring. That means that your credit score could vary from one credit bureau to another, because each method uses different algorithms.
Your credit score is determined by using data in your credit report, such as your payment history, debt owed, length of credit history, new credit, and types of credit used. Any negative information, like late payments, will lower your credit score, but positive info, like getting back on track with your monthly payments, will improve it.
Credit Score Effects on Your Mortgage
Lenders consider many factors, such as your employment status, your savings and salary, or your debt-to-income ratio, when considering giving out a loan. But the most important factor, the one who will have the most influence on what rates you will receive, is your credit score. Also, having a credit score below 620 will make it very hard for you to secure a mortgage. Let’s look at how various credit score ranges will affect your mortgage loan.
- A credit score of under 620. This low credit score will make you fall into the subprime category. A few years ago, you could have qualified for a subprime mortgage with a credit score this low. A subprime mortgage featured high interest rates and not so great terms, but it was an option. Nowadays, very few lenders still offer subprime mortgages, and are very hard to find. A way out if you have a credit score lower than 620 is by making a large down payment, as large as 50 percent of the loan cost.
- A credit score in the 620 to 760 range. Lenders will consider you credit worthy with a credit score in this range, but they will offer you their standard loan options, meaning you won’t receive any deals or special packages.
- A credit score in the 760 to 850 range. This is considered top tier credit score and will yield the best mortgage deals. You will receive the best interest rates and the lenders will give you the most mortgage loan choices.
The most important part of your mortgage loan that the credit score will affect is the interest rate. You might not feel it as much month to month as you are making your payments, but even a small 1 percent difference in your interest rate can add up to thousands of dollars over the life of the loan.
Your credit score is used by lenders to predict your default risk. The more at risk you are, the more your mortgage will cost, so FICO scores are necessary in order to protect lenders. The good news is that you can improve your credit score, which will improve your mortgage terms, saving you money. Before applying for a mortgage loan, make sure that your credit score is in a favorable range. That will make your life much easier, and get you one step closer to your goal of becoming a home owner.