When you apply for a mortgage, your credit score is generally one of the most important factors in determining your interest rate. This can make a big difference when it comes to your monthly payments and how much you spend on interest over the life of the mortgage. Even a 10- or 20-point difference can lead to hundreds of dollars per month in savings or expenses. If you need help finding a mortgage that fits your financial plan, a financial advisor can be especially helpful.
Credit Scores and Mortgage Rates
When you apply for a mortgage, the lender takes a few key factors into consideration. Most importantly, they consider:
- Income and employment history
- Total debt
- Debt-to-income ratio
- Financial history
- Credit score
The lender is looking for a snapshot of your overall finances. They want to decide whether you can pay the loan you’re looking to take, and they do so mainly by looking at your current finances and your financial history. Someone who earns a lot of money and has been at their job for a long time is likely to have the cash flow necessary to pay a larger loan. Someone with a history of making timely payments and handling their finances wisely is likely to continue doing so in the future.
Your credit score is a critical part of this because lenders believe that it reflects your history of paying your bills and managing your finances. In theory, a high credit score reflects someone who has managed their finances responsibly. A low credit score reflects someone who has struggled to do so. This is due to the model on which reporting agencies generate credit, which raises your score when you steadily repay loans and lowers that score when you miss payments on debt.
While your credit score is not the only part of your mortgage application, it is critical. Most lenders will use your credit score to determine if they will give you a mortgage and at what interest rate. Generally speaking, lenders apply the following tiers:
- 760 and above: Excellent credit, eligible for the best interest rates
- 700 – 760: Good credit, eligible for strong interest rates
- 700 – 630: Fair credit, potentially eligible for a loan but at a relatively high interest rate
- 630 and below: Poor credit, typically ineligible for a conventional loan
Even within these tiers, though, you can expect rates to fluctuate. For example, a borrower with a 740 credit score will generally get a slightly better interest rate than a borrower with a 720. Some lenders only change their interest rates based on 20-point credit score intervals, but not all. While your financial background overall makes a huge difference in whether you get a mortgage or not, credit, along with your down payment, are typically the most dispositive elements when it comes to your interest rate.
Why It Pays to Have a Better Mortgage Rate
Here’s the thing to remember about interest rates on a mortgage: they add up, and quick. When we’re talking about mortgage interest, we’re referring to payments on a massive amount of money.
Most borrowers will pay this interest on a loan of $200,000 or more. Even a very small interest rate leads to significant payments when applied to that kind of principal. In fact, for most homeowners, it’s common to spend the first 10 years of a 30-year mortgage primarily making interest payments. That is to say, when you make your monthly payment, most of that payment applies to the interest rather than the loan itself.
As a result, even a small change in your credit score, and therefore your interest rate, can lead to a significant change in your monthly payments. The best way to understand this is by using a mortgage calculator.
As of the writing of this article, the average sale price for a home in the U.S. is just over $475,000, according to the Federal Reserve. Let’s assume this is a first-time home buyer, purchasing an average-priced house with a 20% down payment ($95,000).
Using standard rates, a borrower with a credit score of 680 could expect an interest rate of around 4.05%. Which would give us:
- Credit Score: 680
- Interest Rate: 4.05%
- Monthly Payment (Principal and Interest): $1,825
- Total Interest Paid (Over 30 Years): $276,581
Now, let’s bump our credit score up just a bit. At 700, an average interest rate drops to 3.87%. This gives us:
- Credit Score: 700
- Interest Rate: 3.87%
- Monthly Payment (Principal and Interest): $1,786
- Total Interest Paid (Over 30 Years): $262,451
Even a 20-point credit difference comes to $471 per year in savings, and more than $14,000 in savings over time. Now look at what happens when we make a big jump to a 780 credit score:
- Credit Score: 780
- Interest Rate: 3.4%
- Monthly Payment (Principal and Interest): $1,685
- Total Interest Paid (Over 30 Years): $226,315
A big jump in credit saves you another $1,200 per year, and just over $36,000 over the life of the loan.
Your credit score matters – especially if you’re shopping for a mortgage. Bring a weak score to a mortgage broker or banker and you’re facing a higher interest rate, one that could cost you hundreds of thousands of dollars over the life of the mortgage as well as high monthly expenses. On the other hand, bring an excellent credit score to a mortgage broker you’ll be spared unnecessarily high expenses.
Tips on Mortgages
- Is it time to buy your 0wn place? Many first-time home buyers will drive themselves crazy trying to second guess the market and outthink other buyers. Don’t put yourself in that position. Work with a financial advisor who can help you build a plan that matches your long-term needs. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s mortgage comparison tool to compare mortgage rates from top lenders and find the one that best suits your needs.
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