With home prices starting to come down and interest rates continuing to climb, it is important to understand how your credit score can impact your home buying power because as goes your interest rate, so goes the price of your monthly mortgage payment and thus, overall interest you will pay over the life of your mortgage loan.
What is a credit score?
According to ConsumerFinance.gov, “A credit score is a prediction of your credit behavior, such as how likely you are to pay a loan back on time, based on information from your credit reports. Companies use credit scores to make decisions on whether to offer you a mortgage, credit card, auto loan, and other credit products, as well as for tenant screening and insurance. They are also used to determine the interest rate and credit limit you receive.”
How is my credit score determined?
Your credit history and your behavior toward debt typically form the foundation for your credit score. Six key areas are used to determine the overall score: payment history, current unpaid debt, length of credit history, percentage of unpaid debt (credit utilization ratio), type of debt and how long you’ve had it, and any new applications for credit. An up-to-date credit report is available through, Experian, TransUnion, and Equifax, who all partner together with AnnualCreditReport.com, a free credit reporting site authorized by Federal Law.
How does my score impact my mortgage options?
Mortgage lenders utilize your credit score via a credit report as a barometer for your risk as a borrower. Typically the lower your score and more sporadic your history, the riskier you are to most lenders. To protect themselves from this risk, lenders charge higher interest rates the lower your score. In a sense, this ensures lenders will get back their money should you be unable to pay your mortgage.
As of April 2022, nearly half of all Americans had a credit score of 750 or better. Ted Rossman, a senior industry analyst at Bankrate says, “Every 20 points or so can make a really big difference, especially with mortgage rates.”
Do I Have Other Options if My Credit Score is Lower Than Average?
The minimum average credit score for most mortgages is around 620. For those whose credit scores fall into the range of 500-650, there are loan products available. Some of these programs include the FHA loan, the VA loan, the USDA loan, Freddie Mac, and Fannie Mae loans, as well as some other conventional loans and Non-QM (non-qualified mortgage) loans. For those who may have no debt and therefore no credit score at all, manual underwriting is an option. This is a more personalized approach where an underwriter will take a close look at documents like tax returns, bank statements, and pay stubs to determine your ability to pay back a mortgage loan.
How Can I Improve My Credit Score?
There are several steps to improving your credit score. The first would be to pull a copy of your credit report so that you can check it for any errors or discrepancies. You’ll want to make sure everything there is accurate. Next, aim to pay all of your bills on time. Setting bills up on auto-pay may make it easier to avoid late fees and dings to your credit. If there are any past-due accounts, catch up on those as quickly as possible. Try to avoid or limit applying for new credit. Pay off existing debts. Be wary of any debt consolidation or credit repair scams.
