How Do Credit Scores Impact Mortgage Rates?
Credit scores play a significant role in the homebuying process. After all, a client’s credit score determines the type and rate of mortgage loan for which they can qualify. To help you anticipate and answer any questions they may have about these funky little numbers, let’s dig into credit scores and how they impact the mortgage loan origination process.
What Is a Credit Score?
A credit score is an analysis of a person’s financial life which is “used to determine a person’s creditworthiness,” according to Bankrate.com. It ranges from 300-850, and it’s taken from a credit report typically sourced from a credit bureau like Experian, TransUnion, or Equifax.
The concept dates back to the ‘50s when Fair Isaac Corp. established the FICO score. Nowadays, there are two types of credit score: the FICO score and the VantageScore. The main purpose of a credit score is to determine how likely someone is to pay back a loan based on their past credit history, thus calculating the amount of risk associated with lending to them by analyzing the overall state of their finances.
How Are Credit Scores Calculated?
Though each scoring model's specific criteria varies, there are five factors that most commonly impact someone's credit score:
- The credit holder’s payment history - are payments made on time?
- The amounts owed - how much credit they are utilizing?
- Their credit history age - how long have they held credit accounts?
- Their current credit lines - how many credit accounts are open and used?
- Their new credit - how many new credit accounts have they opened?
It’s important to note that credit scores fluctuate, and, contrary to popular belief, it doesn’t hurt your score to check it. Many credit card companies, banks, and financial institutions have started to provide an updated credit score monthly through bank statements or online within the client’s account. AnnualCreditReport.com is another resource through which your clients can get a free copy of their credit report every 12 months from each of the three nationwide credit bureaus.
Now that you understand what factors into a credit score, let’s break down the various ranges and what they generally mean to lenders:
How Do Credit Scores Impact Mortgage Rates?
Most loan types require a credit score of 620 or higher. The higher the credit score, the lower the interest rate. Scores of 740+ secure the best interest rates. Here’s a rundown of the different types of loans and the credit score your clients would need to qualify for each.
FHA Loans are insured by the Federal Housing Administration, and they’re commonly pursued by folks with credit scores in the 500s. If your client has a credit score of 580 or higher, they could pay as little as 3.5% for their down payment with an FHA loan. If their score is between 500-579, the down payment will rise to 10%.
While these guidelines are typically followed across the board, individual lenders are able to set their own credit score requirements. Lenders will want to make sure that your client’s financial situation is stable through other sources, and they’ll expect any collections, judgments, and most liens to be paid off prior to applying for the loan.
Conventional loans are not insured by the federal government and are broken down into two types:
- Conforming Conventional Loan: the amount of the loan falls within the maximum limits set by the Federal Housing Finance Agency (FHFA)
- Non-Conforming Conventional Loan: the amount of the loan does not conform to the guidelines set by the FHFA
The minimum credit score to qualify for a conventional loan is 620. While that may feel high, qualifying clients will see a decrease in their private mortgage insurance (PMI), which is required if they want to make a down payment of less than 20%.
Joe Parsons, a branch manager and Senior Loan Officer in Dublin, CA, calculates that clients with a credit score of 700-719 will pay 0.73% on their PMI with a 5% down payment. On the other hand, a client with a credit score of at least 760 will only pay 0.41% on their PMI.
VA loans are guaranteed by the Department of Veterans Affairs, and the only qualification is that the borrower must be a veteran, active duty member of the military, or an eligible spouse.
Although there is no government-set minimum credit score to qualify for a VA loan, VA lenders are able to set their own minimum credit score requirements. These minimums will vary depending on the lender but average in the low-to-mid-600s.
USDA loans are guaranteed by the U.S. Department of Agriculture and, like VA loans, don’t require a minimum credit score or down payment. If your clients choose not to submit a down payment, they will have to pay mortgage insurance. Lenders will require their own minimums as well as verifying that the borrower meets certain household income guidelines. Homebuyers must also purchase a property in eligible rural areas as defined by the USDA.
USDA loan applicants with a credit score of 640+ will experience a streamlined process, while those with a credit score lower than 640 will need to meet stricter underwriting standards.
Jumbo loans are loans that exceed the conforming loan limit. Because lending large amounts of money is risky, lenders will be looking for borrowers with a strong credit score and stable credit history.
Most often, jumbo loan lenders look for clients to have a credit score of 700+, though it isn’t uncommon to see a minimum of 720 or 740 depending on the lender.
If your clients don’t have the credit score necessary to qualify, they may be able to obtain a jumbo loan with a co-signer.
Additionally, there are ways you can help your clients improve their credit scores as a professional in the mortgage industry.
Helping Your Clients Improve Their Credit Scores
Your clients may be new to credit scores and unsure of how to improve them. Luckily, they can rely on you and your mortgage expertise! Here are some important actions to undertake for clients looking to improve their credit scores:
- Pay all bills on time as often as possible
- Limit credit card purchases to under 30% of the card’s credit limit
- If possible, pay off each credit card’s balance in full every month
- Keep old lines of credit open to protect their credit’s average age
- Avoid incurring more than one hard credit check (such as applying for a credit card, an apartment, etc.) in a short period of time
- Establish and maintain different types of credit lines to ensure a variety of credit usage
While credit scores can be intimidating to those with little financial experience (and even to those who are trying to push their score higher), mortgage professionals can assuage their clients’ fears and help them take control over their financial future. Empower your clients with these tips and tricks, and we have no doubt that you’ll be known as one of the savviest Loan Officers in town!
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