If you’re buying a home for the first time, keep in mind that the cost of your mortgage can vary depending on your credit score.
Lenders review your financial history to determine how much of a risk you pose as a borrower, and this can have a big impact on the interest rate you’re offered. Your rate, in turn, influences what you’ll end up paying each month and overall for your loan. So, it’s important to understand how your credit score affects your mortgage rate.
Here’s a rundown of the relationship between credit scores, interest rates, and mortgage costs:
Why Credit Scores Matter To Mortgage Lenders
When you take out a mortgage, your lender is allowing you to borrow a large sum of money that it eventually wants back — with interest, of course. So, before it approves your loan, the lender will investigate your financial history to assess how reliable you are as a borrower.
“In a real-world scenario, if a friend asked you for a loan, but they rarely pay you back fully or take forever to return the money to you, how likely are you to say yes the next time they ask?”Brett Bivenour, chief technology officer at FasterFi by Nationwide Mortgage Bankers based in Columbus, Ohio
Your credit score is a number that signifies how likely you are to repay a loan on time. It’s a major factor in your financial profile that influences the interest rates you’re qualified for.
Check out what kind of credit score you need to get the best mortgage rates, according to myFICO:
What Is Considered a Good Credit Score?
|Credit Score Range||Rating||What It Means|
|800 and higher||Exceptional||The borrower’s credit score is much higher than the average, and clearly represents an exceptionally low risk to lenders.|
|740-799||Very Good||The credit score is higher than the average, and represents a very reliable borrower.|
|670-739||Good||The borrower’s credit score is close to or slightly above the average. Most lenders consider this range to be a good score.|
|580-669||Fair||The credit score is below average, but many lenders will still approve loans for borrowers in this range.|
|Less than 580||Poor||The credit score is much lower than the average, and shows that lending to the borrower poses a risk.|
Borrowers buying a house with no credit will likely encounter higher interest rates. If you don’t have a financial track record for lenders to evaluate, they tend to charge more for a mortgage since they can’t accurately evaluate their risk. You’ll need to decide whether it’s worth paying more for your loan in exchange for buying a home now.
How Does Your Credit Score Affect Your Mortgage?
Whether it’s high, low, or nonexistent, your credit score can shape your mortgage in different ways.
“Your credit score matters because it affects both your interest rate and your ability to qualify for a mortgage,” says Deb Klein, branch manager of Reliability in Lending at Primary Residential Mortgage Inc. based in Chandler, Arizona.
Borrowers with lower credit scores often wind up with higher mortgage rates, which means paying more in interest to take out a loan. Those getting a mortgage with an excellent credit score generally score lower interest rates and a better overall deal.
“When lenders pull an applicant’s credit score, three scores are received, one from each credit bureau,” Klein says. “Lenders will then use the middle score to determine your mortgage interest rate.”
If you want to get a mortgage, check your credit report to know where you stand and make sure all the information is accurate.
Mortgage Rates by Credit Score
Think of your mortgage rate as the amount of money you pay each year for your loan, expressed as a percentage. Your annual percentage rate is a broader measure of this cost that includes other charges, such as certain closing costs. The idea is that your APR gives a fuller picture of what you’re paying.
Here’s how the APR on a home loan could be affected by the borrower’s credit score, and how that changes the monthly mortgage payment:
Average APR and Monthly Payment by Credit Score
|FICO Score||Average APR||Monthly Payment|
Why are mortgage interest rates important?
Your mortgage rate determines the amount of interest you’ll be charged for your loan. A higher interest rate means that you’ll have a more expensive mortgage and bigger monthly payments compared with a loan that has a lower interest rate.
In an example, let’s say you’re taking out a 30-year, fixed-rate mortgage for a $500,000 home with a 20% down payment:
How Mortgage Rates Affect the Monthly Payment and Total Interest Paid
|Home Purchase Price: $500,000|
|Down Payment: 20%|
|Loan Term: 30 years|
|Interest Rate: 4%||Interest Rate: 5%|
|Monthly Payment: $1,910||Monthly Payment: $2,147|
|Total Interest Paid: $287,478||Total Interest Paid: $373,023|
This example shows that a difference of 1 percentage point in the interest rate means paying $237 more per month and $85,545 more overall for the same loan.
How To Improve Your Credit Score
If your credit score is currently on the lower end, working to improve your score before applying for a mortgage could help you save money in the long run.
Here are some tips to help boost your credit score over time:
- Catch up on overdue bills. If you miss a loan or credit card payment by 30 days or more, the late payment may be reported to credit bureaus and hurt your score. Late payments also stay on your credit report for up to seven years. If you’re falling behind on bills, it should be a top priority to get them paid and prevent additional blemishes on your report.
- Pay your bills on time. Having a history of on-time payments helps you prove yourself as a reliable borrower. Klein suggests setting up automatic payments with your bank account if you’re new to using credit or worried about forgetting to pay bills on time.
- Keep your credit utilization low. Your credit utilization ratio represents how much of your revolving credit you’re currently using. “Keep your ratios on your available open credit cards to no more than 30%,” Klein says. “For example, let’s say you have a limit of $1,000 on a credit card. Do not charge more than $300 at any given time and don’t keep a balance of more than $300 to not exceed the 30% threshold.”
- Avoid opening new lines of credit. When you apply for a line of credit, the lender pulls your credit during the review process. That request to view your credit report counts as a hard inquiry, which can ding your credit score.
- Verify the information on your credit report. You can get a free copy of your credit report every year from each of the three credit bureaus by visiting AnnualCreditReport.com. You can dispute inaccurate information by contacting the credit bureau and your lender.
Additional Mortgage Resources
Your home loan could be the biggest financial commitment you make, which means you should seek out all the knowledge you need before making any big decisions.
Here are some additional guides to help you navigate the mortgage process:
- 15 Important Questions First-Time Homebuyers Should Ask Lenders
- How Much Down Payment Do You Need To Buy a Home?
- 15-Year vs. 30-Year Mortgage: Which Is Better?
- The Ultimate Guide to Different Types of Mortgages
- What Is a Jumbo Loan and When Do You Need One?
- How To Compare Mortgage Offers
- What Is Mortgage Amortization and How Does It Work?
- What To Know About Buying a House With Your Partner Before Marriage
- How To Find a Real Estate Agent in 7 Steps
The Bottom Line: How Does Credit Affect Buying a House?
When it comes to getting a mortgage, your credit score could make a big difference. The relationship between credit scores and interest rates is negatively correlated — which means that if you have a higher credit score, then you’re likely to get a lower interest rate. This also means your monthly payments will be less expensive, and you’ll pay less interest in the long run. So, before you apply for a mortgage, be sure to check your credit to determine if now is the best time for you to buy a home.