You’ve probably heard that you need to have a good credit score to buy a home, but unless you’ve done some research, you might not fully understand the effects your score can have on your mortgage.
Learn more about why your credit score is important and what you can do to improve it.
Credit Scores in a Nutshell
It can range from 300 to 900 and the higher the score, the better. The companies arrive at your score by looking at how good you are at paying your bills on time, how much money you owe compared to how much credit you have available, the length of your credit history, the mix of types of credit, and whether or not you’ve recently opened new accounts.
Surprisingly, those who have never had a loan or credit card because they prefer to save up and pay cash can have low credit scores. This is because there’s simply no data available.
Can You Qualify for a Mortgage?
Most importantly, your credit score will determine whether or not you’ll qualify for a mortgage. In most cases, lenders look for scores of 650 or higher. If you're married, the lender looks at both credit scores. This is troublesome when one person has a higher score than another. It might be better to apply for the mortgage in just one person’s name if their income is enough to cover the monthly payments.
Low Scores Mean High Rates
Even if you qualify for a mortgage, a lower score will mean you’ll have to pay higher mortgage rates. There can be as much as a three percent difference in loan rates between high and low credit scores. That might not sound like a big difference, but it certainly adds up.
For instance, a $400,000 mortgage with good credit, you might get a 3.5 percent rate. That would mean monthly payments just under $2,000, and over the lifetime of the loan, you’d pay almost $200,000 in interest. If the interest rate was 6.5 percent instead, your monthly payment would be around $2,500, and you’d pay more than $370,000 in interest.
It’s important to note each lender has their own requirements and certain credit scores might be on the cusp. One lender might give you their best rates on your mortgage, while another might consider you second-tier. That’s why you should always apply with a few different lenders to compare rates, including the builder's preferred lender.
Improving Your Credit Score
Order a copy of your credit report to see where you stand. Even if your score is high enough to qualify for a mortgage, you can still work to improve your credit to get better rates before you need to apply for your mortgage.
If your score is low simply because you don't have a lot of credit, you can improve your score simply by applying for a credit card or two and paying your bills on time. If your score is low because you’ve made some mistakes in the past, you need to pay down any debt you have and make sure you consistently pay your bills on time.
Those who already have high scores need to make sure they keep their scores high. Don’t miss any payments and avoid taking on debt.
Improving Rates with Refinancing
If you're buying your first home and have little credit history, you may have to settle for current mortgage rates. Simply getting a mortgage can start to improve your credit score because it creates a better mix in your credit profile. Setting up automatic payments for your mortgage means you’ll never miss a payment. Once you have a proven history with your lender, then consider renegotiating your mortgage in a few years to get their best rates.
Do You Need Credit Repair?
Many companies offer to help you improve your credit score for a fee. These companies might fix mistakes on your report or consolidate your loans to make them easier to pay. However, it’s important to try to do all of these things on your own and paying a company to help fix your credit should be a last resort.
Your credit score is an important piece of the puzzle when it comes time to get a mortgage. Fortunately, when you know how to keep your credit clean, you’ll be in a good position to buy the home you've always wanted