Why Your FICO Score Matters to Lenders
Most of us know that you need to have “good credit” to get a mortgage loan. But, did you know that without a high credit score, you won’t be able to get the best mortgage rates available? Why is this the case?
This is because lenders would rather take a chance on borrowers who have established an on-time payment history. These borrowers are more likely to be serious about meeting their obligations, and are more likely to pay back their lenders. Someone with a spotty payment record is a higher risk, and the lender offsets this risk with higher rates.
Most of the time, your credit score is calculated using the FICO (Federal Insurance Contributions Act) scoring model. This combines information found on your credit reports, compiled by the credit reporting companies. These reports contain all the details of your past payment habits.
If your credit score could be a stumbling block for you, just keep in mind that while it’s one of the most important pieces, it’s still just part of your entire application. The additional elements your lender will consider? Sufficient assets, income, and credit.
Best FICO Scores For Conventional Loans
It’s still possible to qualify for certain kinds of loans if your FICO score is under 680. But if you’ve got a FICO score of 700+ (especially, say, 760 or above), you’re usually sitting pretty and can feel confident about getting a good interest rate.
For a little more perspective on the lower end of a FICO score: 680 is considered average, while 640 might put you in jeopardy of not securing a traditional loan (meaning a loan backed by Fannie Mae and Freddie Mac) from a bank or online lender.
The lending industry has created a credit score scale that’s laid out in 20-point increments. The rates offered to borrowers gets adjusted each time a credit score moves up or down by about 20 points. So a change in score from from 740 to 720, can increase you monthly mortgage interest expense and significantly increase the monthly cost of private mortgage insurance (PMI). It’s known as “loan-level pricing,” and every time you go down a level, your costs increase.
Example: How 60 Points Can Change Your Payment
The chart below shows the increased cost of a 30-year $400,000 mortgage with a 5% downpayment,* when the buyer has less than a 740 credit score.
What happens if your score was an “average” 680 instead of 740? You’d be looking at an extra $216 a month in interest and mortgage insurance ~ that’s $2,592 per year.
Bottom line: you’d be paying an addition $77,760 over a 30-year period.
On the other hand, the impact of a 720 score vs. a 740 score isn’t so huge that you should derail your plans just so you can raise it – especially if it turns out that mortgage rates went up while you were scrambling to boost your FICO score.
What Other Loan Options Are Out There?
In the world of conventional loans, a lot is riding on your credit score. But what if this route just isn’t an option? It might not be the end of the road for you.
Government-Insured FHA & VA Mortgages
These may sometimes accept a score as low as 580. It’s certainly worth a try – with government loans, you’ll generally find more leniency when it comes to both your credit score and underwriting guidelines. The downside: the loan fees on FHA loans are usually considerably more expensive since you’ll need to pay both an upfront mortgage insurance premium and annual private mortgage insurance.
Don’t give up hope! If one lender says you’re not qualified, it may simply mean you’ll need to investigate and find someone willing to accept your credit situation on its face or someone to assist you with getting into a better credit situation.
Check Your Credit Ahead of Time
We highly recommend checking your FICO score at least 6-12 months before you’ll need it to apply for your mortgage. Your credit score is simply too important when it comes to both the mortgage rate you’ll receive and whether you’ll receive financing at all.
If you go shopping for a mortgage without knowing your credit score months in advance, you’ll feel stressed out as you rush to make the necessary changes – if you have time to make changes at all. Credit mistakes can sometimes take several months to complete.
Otherwise prepared buyers find mistakes on their credit all the time. Even if an item on your report is an error it can still decrease your credit score substantially, maybe even by a percentage point or more.
Wondering How To Fix Your FICO Score?
We’ve spent lots of time talking about the importance of your FICO score: why it matters to lenders, why it should matter to you, and what different scores might mean for your financing options.
If you’re ready to dedicate yourself to improving your low credit score, however, stay tuned – in an upcoming post we’ll make sure you know everything you can do to increase your FICO score.
When it comes to your dream of owning a home, it’s never the end of your story.