Buying your first home is an exciting milestone, but navigating the world of mortgages can feel overwhelming, especially if you’re not sure where your credit score stands. Many first-time homebuyers and young professionals are surprised to learn just how big of an impact their credit score can have on their ability to secure a mortgage and the interest rate they’ll pay.
This blog will break down why your credit score matters to mortgage lenders, how it directly influences your loan terms, and actionable tips to quickly improve your score. By the end of this post, you’ll feel more confident taking on the home-buying process!
What Is a Credit Score and Why Does It Matter?
Your credit score is a three-digit number that represents your creditworthiness. It’s like a financial report card that tells lenders how likely you are to repay borrowed money. Most credit scores range between 300 and 850, with higher scores indicating stronger financial reliability.
Lenders, including mortgage lenders, use your credit score to:
- Assess their risk in lending to you.
- Determine the interest rate you qualify for.
- Set the terms of your mortgage, like the down payment requirement.
Generally, a higher credit score translates to lower interest rates and better loan terms, potentially saving you thousands of dollars over the life of your mortgage. On the flip side, a low credit score may result in higher interest rates, or worse, you could be denied a loan entirely.
How Your Credit Score Affects Your Mortgage
When it comes to mortgages, your credit score influences more than just approval odds. Here are the key factors it affects:
1. Interest Rates
Mortgage lenders use a tier system to assign interest rates. For example:
- A score of 760 or higher may earn you the lowest interest rate.
- A score between 620 and 759 typically results in moderate-to-high rates.
- A score below 620 often leads to much higher rates, or even a requirement to seek financing through specialized lenders.
Even a small difference in your interest rate can significantly alter your monthly payment. For instance, on a $250,000 loan, a 1% higher rate could cost you an extra $150 or more each month.
2. PMI Requirement
If your credit score is below a certain threshold, you might need to pay private mortgage insurance (PMI). This additional cost protects the lender in case you default on the loan, but it means higher monthly payments for you.
Borrowers with higher credit scores can often avoid or minimize PMI.
3. Loan Amounts and Terms
Poor credit may limit the amount you’re approved to borrow. Lenders mitigate risk by offering smaller loans to individuals they consider high risk. Additionally, your credit score can influence the length of your mortgage term (e.g., 15 years versus 30 years).
Tips to Boost Your Credit Score Fast
If your credit score isn’t where you want it to be, don’t worry. There are steps you can take to improve it in both the short- and long-term. Here’s how:
1. Pay Down Credit Card Balances
Your credit utilization ratio (the percentage of your available credit you’re using) has a significant impact on your score. Aim to keep your utilization below 30%, and ideally under 10%, to demonstrate responsible credit habits.
Quick Tip: If you have a high balance on one card, try transferring part of the balance to another card with a lower usage percentage.
2. Review and Dispute Credit Report Errors
A surprising number of credit reports contain errors, such as incorrect account information or inaccurate late payment records. Obtain your free credit report at AnnualCreditReport.com and review it carefully. If you spot any errors, dispute them immediately with the credit bureau.
3. Pay Bills on Time
Payment history is the most significant factor in determining your credit score, accounting for 35% of the total. Even a single late payment can have a noticeable impact. Set up reminders or automate payments to ensure your bills are always paid on time.
Pro Tip: If you’ve missed any payments recently, contact your creditor to see if they’ll consider removing the late mark after it’s been resolved.
4. Avoid Opening New Accounts
While it’s important to have a mix of credit types (like credit cards, student loans, or car loans), opening too many accounts in a short period can hurt your score. Each application results in a “hard inquiry,” which can lower your score temporarily.
5. Keep Old Accounts Open
The length of your credit history matters. Closing old accounts, especially those in good standing, can hurt your average account age and reduce your credit score. Even if you don’t use a card often, it can be beneficial for your score to keep it open.
6. Consider a Credit-Builder Loan
If your credit history is limited or your score is low, a credit-builder loan can help. These small loans, offered by some community banks and credit unions, are designed to help build credit over time when you make consistent, on-time payments.
The Bottom Line on Credit Scores and Mortgages
Your credit score plays a pivotal role in determining your mortgage options. A higher score can unlock better interest rates, reduced PMI, and favorable loan terms, saving you thousands of dollars in the long run.
If your current score isn’t where you’d like it to be, don’t give up. With a proactive approach to managing your credit, you can improve your financial standing and increase your chances of securing your dream home.
Allied Residential Mortgage: The Smart Path to Homeownership
Allied Residential Mortgage is much more than one of the top mortgage brokers. ARM is also a family, with business relationships going back over 25 years.
Our founders cultivated a culture of integrity and collaboration. In the process, they created something special: a family, and we want you to be part of it.
