A credit score is extremely important as it directly affects mortgage rates. A difference in just a few points will either cost or save you a fortune. Therefore it is essential to know what exactly a credit score is and what you can do to get better mortgage rates.
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What Is a Credit Score?
A credit score is a numerical value ranging from 350 to 850 that accounts for how trustable a customer is to pay off their debts. A potential lender will never know if it is safe to lend you money and whether you will ever return the money. This is where a credit score is used to depict your trustworthiness. Companies like FICO base their score on your credit history, number of open accounts, total levels of debts, number of loans taken, and other factors and assign you a number between 350 and 850. The higher your score, the more trustable you are, and lenders will be confident to lend you money because it is of lower risk for them. This is why you are more likely to get good interest rates than someone with a bad credit score, as most lenders will not be interested in lending them money.
What Credit Score do you Need for the Best Mortgage Rate?
Your credit score has a significant impact on your financial life as It governs whether or not a lender would provide you credit. So that begs the question, what is a good credit score to get the best mortgage rates?
Only 1.6% of Americans have a perfect credit score of 850 points. So, a credit score of 750 or higher is typically associated with a great credit score, and while you can still qualify for some loans with a score of less than 680, the 700s are where you can expect to pay the lowest rates.
It is entirely up to the creditor to choose what makes an acceptable score, although the following are standard guidelines:
- A score of 800 or higher is considered an excellent credit score, and you are most likely to get the best rates on a mortgage.
- 740 – 799 is still considered an excellent credit score as you belong to the top 25%, and lenders will still give you decent rates, although maybe a tad lower than perfect.
- 670 – 739, in general, is considered as a fair credit score with many opportunities for an affordable rate up for grabs.
- 580 – 669 is considered as a poor credit score. You can still find willing lenders with a score in this range, but the mortgage rates will be significantly higher.
- 300 – 579 is considered a very poor credit score, and you are unlikely to get lenders with this credit score. Even if you manage to find any lender, the interest rates will be astronomical.
The industry standard is to increment rates at every 20 point difference. So if you can increase your score from 740 to 760, you are likely to get a small reduction in the interest rates you are being offered.
How Much Can a Good Credit Score Save You?
It is important to understand that when comparing mortgage rates, the difference may appear insignificant at the start. The difference between 4.53 and 4.73 may seem insignificant at the beginning, but over the course of 30 years, these low rates can add up and save you a fortune.
So how much exactly do you save? Let’s look at this credit score chart for reference.
Consider you want to buy a house that costs $350,000. You pay 20% as a down payment and the rest over a period of 30 years.
| Credit Score | APR | Monthly Payment | Total Interest Paid |
|---|---|---|---|
| 800 or higher | 4.013 | $1634 | $202,279.75 |
| 740 to 799 | 4.186 | $1662 | $212,449.70 |
| 670 to 739 | 4.562 | $1725 | $234,480.28 |
| 580 to 669 | 4.84 | $1771 | $251,678.88 |
| 300 to 579 | 5.34 | $1857 | $282,683.09 |
We calculated this table using a mortgage calculator. You can check your own rates using this tool.
From the table, you can clearly see that having an excellent credit score and a poor score will make a difference of only around 1.3% in interest rate. Anyone can discard this, thinking such a slight percentage increase will not be that significant. But this is where they would be wrong. If you see the column at the right, the total interest you pay in 30 years will add up to over $80,000.
It seems uncanny, but having a couple of points redacted from your credit score may cost you a fortune, as illustrated in the table. Even for small increments like having a score of 720 and 740 may end up costing you $12,000.
However, interest rates aren’t the only consideration. A higher interest rate not only means a greater monthly payment, but it also means you’ll pay off less principal early on in the loan.
Someone with a 670 – 739 credit score will have paid $124,624.48 in total over ten years, but just $61,145.52 will have gone toward the debt. A person with a 740 – 799 credit score, on the other hand, would have made $113,689.34 in total payments, over $11,000 less than someone with a lower credit score, but would have paid $63,890.66 of the principal amount—almost $2700 more than someone with a lower credit score.
How to Improve Your Credit Score
Now that we have looked into the importance of a good credit score and the difference even a slight increase in credit score can make, let us shift our focus on how we can improve credit score.
- Pay all your bills on time: The best way to improve your credit score is to pay off your bills on time. You would need six months of on-time payments to have a noticeable change in your credit score.
- Maintain a low credit utilization: This is one mistake many people make is to utilize more than 80% of their credit card limit. It would be best if you ideally wanted to keep your credit utilization at 50%, so, for example, your credit card has a limit of $5000. Make sure you do not use more than $2500 and pay off the amount in full before the due date. If you find yourself consistently utilizing more than 80% of your credit limit, you may apply for a credit increase.
- Don’t close a credit card account: Contrary to popular belief, it is actually not a good idea to close your credit card if you are not using them. Now, we understand having multiple cards will result in additional fees, but this, in turn, can be beneficial for your credit score. For example, you have $1200 in debt and have a credit limit of $5000 split between two cards. If you close one card, your credit limit now decreases to $2500, and you are using half of it, whereas previously, your credit utilization was lower. Remember the rule of thumb, the lower the credit utilization, the better credit score you get.
- Hire an expert company: If you do not have the time to improve your credit score yourself, you may consider hiring a credit repair company on your behalf. For a fixed monthly fee, they will do everything necessary to improve your credit score.
Apart from these, you can also improve your credit score without using a credit card. Here is an in-depth article to help you further enhance your score.
Bottom line: You Need an Excellent Credit Score for the Best Rates
So what exactly do all these mean? Planning is critical when it comes to finding the best mortgage rates. When you have decided to purchase a house, you should realize that this is a considerable investment for the next 30 years of your life. So, instead of rushing into it, make a proper plan. First, check your credit score and see what interest rates you are offered.
Next, consider following the steps we have discussed, like reviewing your credit reports for inaccuracies, reducing your debt usage by paying off your credit card balances in full each month, making all of your payments on time, and trying to improve your overall score.
If you are planning to pay off less than 20% in downpayment for the purchase of your new home, you must have a credit score of 760 to 780 to get the lowest mortgage rates. But if you plan to pay off more than 20% as a downpayment, a credit score of 740 may be enough. But you are advised to evaluate all your options before pulling the trigger.
It is essential to understand that even an increase of 10 points can significantly improve your interest rates and save you a lot of money in the long run. So, even if you don’t have a perfect credit score, it may be worthwhile trying to increase it just a little bit to avail a lower interest rate. It will definitely make up in the long run.
