For people who are planning to purchase a home or an investment property, paying attention to credit scores early on in the process is critical. Ideally, consumers should know their credit score and whether or not it needs improvement at least a year or more before purchasing property, though regularly checking your credit report for fraud and identity theft is best.
When it comes to applying for a mortgage, lenders want to know that the borrower has a reliable history of using and repaying credit. Lenders use FICO scores, which range from 300 to 900, as a benchmark for determining this reliability. For example, a FICO score of 620 is typically required for government home loans along with a 3.5 percent down payment. Scores lower than 620 are sometimes accepted, but they might require a much larger down payment.
For a conventional loan, most lenders want to see a FICO score of about 640 or higher. Of course, these numbers can vary depending on the lender chosen and what mortgage products they have available. What’s important to remember is that the better your FICO score, the more likely your chances of being approved for a loan and securing a lower mortgage rate.
To put it in perspective, a person with excellent credit (760+) may qualify for a 30-year mortgage of $150,000 with a 3.5 percent interest rate, resulting in a monthly payment of about $674, excluding taxes and insurance. For someone with fair credit (640), the same loan with a 4.5 percent interest rate will result in a monthly mortgage payment of about $760. Factoring in amortization, that’s a payment increase of nearly $1,500 in the first year, or over $31,000 over the entire life of the loan.*
If you are concerned about how your credit score might affect your mortgage rate, there are steps that can be taken to improve your credit. The simplest include making on-time bill payments, avoiding unnecessarily closing credit card accounts even when they are paid off, reducing all credit card balances to below 30 percent of the card’s limit and making sure that your credit behavior is consistent. Additionally, you can speak with a mortgage consultant for more advice on improving your credit and evaluating your mortgage options.
* Based on calculations using Prosperity Home Mortgage’s mortgage calculator