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Lenders typically advertise the rates that are available for their most attractive prime customers. These customers typically have great credit scores, says David Reiss.
You may not realize it, but the most influential determinant of your mortgage rate is your credit score. The higher your credit score, the lower the interest rate on the mortgage.
''A credit score, by definition, is a number that predicts how reliable you are about paying off a loan - and a mortgage is almost always the biggest loan any of us will ever sign up for,'' says Howard Dvorkin, CPA and Chairman of Debt.com, an expert who has been in the industry for over 20 years.
Moreover, your credit score will determine if you can get a home loan at all. Buyers below a certain threshold will have a difficult time obtaining a mortgage loan.
How can you determine what a good score is and what a bad score is? Credit scores are determined on a number of different factors, and no one really knows exactly how they are calculated since those formulas are proprietary to the companies using them.
Scores typically range from around 300 to 850 with the average credit score in America being at about 687.
Along with a few other factors, having a good credit score is essential to securing a mortgage at a decent rate as it determines how risky the borrower is. Tim Milauskas at First Home Mortgage explains:
''The riskier the loan, the more adjustment to the price of the loan, and the higher the mortgage rate. Fannie Mae and Freddie Mac have tiered credit score criteria when determining risk and ''loan level price adjustments'' that they use to gauge the risk of each loan. They charge lenders for riskier loans, and that charge is passed on to borrowers. Factors such as loan-to-value (the amount borrowed versus the value of the home), intended use of the property (primary residence, second home, investment property), and credit score are all factored into these loan level price adjustments.''
As a rule of thumb, a credit score of 740 or higher qualifies for the best interest rates from most lenders.
''A borrower with a 740 or better credit score should expect to see a significantly better interest rate than a borrower with a 660 credit score. This has been the pricing method for years. Better credit scores result in better interest rates, saving potentially thousands or tens of thousands of dollars in interest over the life of the loan,'' says Milauskas.
The difference between the best and worst rates can vary up to a full percentage point and a half!
Let's look at the credit rates for people with three different credit scores:
Credit score of 620: 6.2 percent
Credit score of 700: 4.8 percent
Credit score of 780: 4.6 percent
Clearly, your credit score significantly impacts your mortgage rate. ''Lenders typically advertise the rates that are available for their most attractive — prime — customers. These customers typically have great credit scores,'' says David Reiss, an expert at residential real estate and Professor at Brooklyn Law School.
If you don't think a difference in a percentage point will make a big difference to your payments, you're mistaken. One percentage point can make a big difference! Consider this example of monthly principal and interest payments on a 30-year fixed rate mortgage for $250,000:
Monthly principal and interest
''At some point, [lenders] won't offer credit at all — they will reject you for not meeting their underwriting standards,'' explains Reiss. It starts getting tricky with a credit score of 620 and under, which makes it imperative to keep your credit score in good shape.
Lenders prefer borrowers with low balances, a long history of on-time payments and a mix of credit utilization – for example, a car loan and a couple lines of revolving accounts. Your credit score is based upon a couple of different factors including:
''The more access you have to credit and the less you use it, the better your score. And paying down or paying off balances monthly results in a higher score,'' explains Milauskas.
If you are looking to take out a mortgage loan in the future, it's important to get your credit back on track to get the best rate.
Know your Numbers : Reviewing your credit reports and scores is imperative to applying for a mortgage. This is the first step in evaluating whether you're ready to apply for a mortgage. You can get your credit reports for free once per year. Check out these free credit reporting and monitoring services .
On-Time Payments: Making payments on time is one of the most important factors in keeping your credit intact. Delinquencies are incredibly damaging to your score, which can cost you more in the long-run.
Pay off credit card debt : Reduce what you owe on your credit cards to lower your credit utilization ratio quickly. This is key to giving your credit score a boost.
Hold off on new inquiries : Every new loan application lowers your credit score a little bit. Avoid apply for new credit or loans until after you've closed on your new home.
Save, save, save : This won't exactly effect your credit score, however, it will make you look less risky to lenders. Lenders will want to see that you have savings to cover unexpected expenses of homeownership.
Comparing Mortgage Rates
If you are worried about your credit score, you should compare rates from lenders and shop around. Reiss of Brooklyn Law School explains that ''different lenders have different rates and different underwriting standards. Some lenders, like those offering FHA-insured mortgages, may offer mortgages to those with credit scores that other lenders would not lend to.''
Be Smartee makes it easy to compare hundreds of loans at once, accessing real-time rates and fees. Search for loans and apply online to see if you are approved instantly.
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