Mortgage Rate vs. Credit Score

Credit scores have an effect on mortgage interest rates.

Credit scores have an effect on mortgage interest rates.

A credit score is the greatest determinant of a borrower&amp;#039;s mortgage interest rate. When the score is high, it will generally ensure a low rate. When it is low, however, it will increase the rate and may actually cause a loan to be denied. To prepare for the eventuality of purchasing a home, you must understand the loan underwriting process that depends greatly on your credit score.

What is a Credit Score?

The mortgage lending industry uses three different credit reporting agencies to help them determine a potential borrower&#039;s ability to repay a loan. Experian, TransUnion and Equifax collect financial information about everyone with a social security number from banks, credit card companies, employers and other businesses. They process that information with a proprietary algorithm developed by the Fair Isaac Corporation (FICO) to calculate individual scores to determine your creditworthiness.

How is a Credit Score Calculated?

Your FICO score will range between 300 and 850. Most people score between 600 and 700. Those with scores above 700 are low-risk, preferred borrowers who will receive the lowest interest rates from lenders. Those with credit scores below 600 are high-risk borrowers who pay the highest interest rates or who may be declined for a loan. A FICO score considers five different aspects of an individual&#039;s finances. Your payment history will account for 35 percent of the score. Another 30 percent is determined by the amount of money that you owe on all active accounts, and 15 percent is determined by the length of your credit history. Loans that may recently have been applied for contribute 10 percent to the FICO score, and the last 10 percent is determined by the mix of credit that you have, such as credit cards and installment and personal loans.

Why Does a Credit Score Affect a Mortgage Rate?

A FICO score suggests a person&#039;s creditworthiness; that is, how likely it is that a loan will be repaid. A high score implies financial maturity that ensures timely loan repayment, whereas a low score suggests a cavalier attitude toward money and credit that is demonstrated by late payments, excessive credit and liens and garnishments.

Statistical Facts About Credit Scores and Mortgage Delinquent Rates

According to Lending Tree, the mortgage industry has compiled data that correlates borrowers&#039; credit scores with the statistical odds of their monthly mortgage payment delinquencies. The odds of a borrower with a 780 FICO score becoming 90 days delinquent, for instance, are only 1 in 576. As the score drops to 680, however, the odds increase to 1 in 144, and they further drop to 1 in 4 for those with a 600 score. It is no wonder, then, that lenders use FICO scores in their decisions to lend money.

How can a Credit Score be Improved?

Since each one of the three credit reporting agencies collects information independent of each other, their FICO scores may not be alike. The first step in improving a credit score, therefore, is to learn what information each agency has collected. You can request a copy of your credit history once a year, free of charge, from each agency, but the corresponding FICO score may have to be purchased separately. Carefully scrutinize the credit histories for incorrect information, and notify the bureaus accordingly. Scores will increase markedly when overdue debts are paid off. They will also rise when bills are paid on time and will continue to improve as you exercise responsible money management.

About the Author

Ray Anderson is a professional freelance writer who was the monthly real estate columnist for the “Northern Virginia” magazine and the weekly business columnist for the Maryland-based “Metropolitan Tribune” newspaper. He has written for internet websites and has developed business literature for different companies. Anderson is a licensed Virginia real estate broker and licensing instructor who studied electrical engineering at the University of Maryland.

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