How does a low credit score affect my mortgage rate?
The lower your credit score, the higher your mortgage interest rate will probably be. If your credit score is below 650, it's unlikely a lender will improve your application for a loan.
But what makes a good credit score? Is there any way to calculate how much interest you would have to pay on a loan based on your current credit score?
The relationship between credit credit scores and interest rates
Unfortunately, there's no way to confirm what your interest rate would be on a loan, but why is that the case? Your credit score isn't the only thing lenders take into account when assessing your ability to handle a mortgage. Your projected income, debt-to-income ratio, and down payment all affect the interest on the loan.
However, there are a few ball-park percentages you can use as a guide. FICO listed several credit score ranges and the interest rates you may have to pay on a mortgage:
- 760-850: 3.18 percent
- 700-759: 3.41 percent
- 680-699: 3.58 percent
- 660-679: 3.8 percent
- 640-659: 4.23 percent
- 620-639: 4.78 percent
You may not think there's much of a difference between a 3.4 percent interest rate and a 4.23 percent interest rate, but you'd be surprised how much the costs can add up. Assuming you're taking out a $200,000 loan and using FICO's calculations, you'd pay an additional $1,128 a year in monthly payments if your credit score was between 640 and 659.
The type of mortgage and and lender
Your interest rate also depends on what kind of mortgage you're getting. For example, if you're getting a non-conforming loan (a mortgage that exceeds $417,000, according to Bankrate), you'll likely need a better-than-average credit score, greater than 700. The Wall Street Journal spoke with John Walsh, CEO of Total Mortgage Services, who explained that, to get the best rates on a jumbo mortgage, you'll probably need a credit score of at least 720.
There are institutions that specifically cater to those with low credit scores, the Federal Housing Administration being one of them. The FHA offers loans to those with credit scores of 580, but borrowers need to put at least 3.5 percent down on the homes they purchase. Those struggling to improve their credit usually go to the FHA because it also offers lower interest rates than private lenders.
What can you do to improve your credit score?
Getting your credit score to where you want it to be can take a while. As a general rule of thumb, paying your credit card bills on time is an easy way to improve your credit score. If it's within your means, pay more than the minimum amount due each month. This behavior will add up overtime and increase your credit score.
Also, consider the merits of getting an alternative credit score. While traditional lenders don't usually reference nontraditional credit reports, more mortgage professionals view alternative credit scores as legitimate indicators of people's ability to pay back loans. In addition, according to law, a lender must take an alternative credit report into account if you provide it to them.