How your credit score affects your mortgage

August 17, 2016

When you’re shopping for a home, you can find yourself fixated by mortgage rates and obsessed with trying to lock in the lowest rate possible. But the first thing you should do is check your credit score. (You may be able to get your score for free through a credit card issuer or membership organization, or through any number of resources online.)

Your credit score affects a bank’s decision on whether to lend you money, how much to lend you and most notably, what interest rate to charge. It’s not the sole factor, but it’s an important one. (Other primary considerations include your income, your employment history, and your down payment amount.) A higher interest rate means a higher monthly payment – that could mean you are able to borrow less money, which in turn would mean that you can afford less house.

Most lenders offer their lowest interest rate to borrowers with a credit score of 740 or more. You’ll get somewhat higher interest rates with a score between 620 and 740. Those with a score below 620 may find it difficult to get a mortgage at all. (Even though mortgage insurers such as the FHA and VA have no or lower minimum credit score requirements, lenders will often decline to issue mortgages to those with scores lower than 620.)

How important is a great credit score? The difference between the best and worst interest rates on a mortgage can be as much as 1.5%. Assuming a 30-year mortgage of $100,000 at a best-fixed rate of 3.5%, your monthly payment would be $449. At an interest rate of 5%, your monthly payment would be $537, a difference of $88 per month or $1,056 per year. Over the life of the loan, that works out to an additional $31,600 in interest if you have a low credit score!

To get the best rate possible, check your credit score before you start shopping for a mortgage. If it could use some improvement, start by going to AnnualCreditReport.com to get a free credit report, then review it carefully and dispute any errors. Don’t close any credit cards or apply for new credit, since such actions can lower your credit score.

Pay off any balances owed if possible. If you have any past due accounts, pay those first. However, if the late payment is a rare occasion, try asking your creditor for a “good faith adjustment” to remove the late payment from your credit report. If you can’t pay off balances, at least try to pay them down. Start with revolving debt, such as credit cards, and leave installment loans like a car loan for last. Finally, be sure to make any and all payments on time.

Since it can take some time to raise your credit score through the actions described, you’ll want to start as soon as possible in the home-buying process.

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