Home ownership remains a long-standing dream for many people, and most prospective homebuyers require financing - normally, in the form of a mortgage - in order to achieve this goal. Did you know that your credit score is among the key factors used by mortgage lenders to determine your interest rate and payment terms? Here, we take a look at credit score and how it weighs in on your mortgage payment.
What's Your Credit Score?
Essentially, a credit score is a number used by lenders to determine how likely you are to pay back a loan. Credit scores generally range from 300-850, and they are calculated using information contained within your credit reports. Most lenders view higher credit scores more favorably than lower credit scores as they indicate greater likelihood of payback; therefore, it is in your best interest to boost your credit score as high as you can before you apply for a mortgage.
How Is Your Credit Score Calculated?
Components of your credit score include whether or not you pay your bills on time (i.e. payment history), the total amounts owed (usually, as a percentage of credit outstanding), the length of your credit history, how much of your credit is new and the types of credit used. Have a look at the chart below, which breaks down each factor's weight in the calculation of credit score. As you can see, your payment history accounts for 35% of your credit score, which makes it the most meaningful component of your credit score.
|Length of Credit History||15%|
|Types of Credit||10%|
How Does My Credit Score Determine My Mortgage Payment?
To put it simply, the higher your credit score, the lower your mortgage interest rate. Several online loan calculators illustrate this point; using the MyFico.com loan calculator, we see how borrowers with a credit score ranging from 760-850 merits around 3.55% mortgage interest rate on a 30-year fixed-rate mortgage, whereas borrowers on the lower end of the credit score spectrum see less desirable interest rates (e.g. a borrower with a credit score ranging from 620-639 might see his/her interest rate at about 5.139%). Of course, this example is presented for illustrative purposes only; the best way to determine your mortgage interest rate is to speak with a mortgage lending professional.
|Credit Score||Interest Rate||Monthly Payment||Total Interest Paid|
How Do I Improve My Credit Score?
To improve your credit score, it is important that you pay all of your bills on time. Recall that payment history is the largest determinant of your credit score; therefore, any missed or late payments are sure to harm your credit score.
Amounts owed on existing credit lines also factors into your credit score (30% weighting). Your credit score will likely improve if you lower your credit card balances ("maxed out" credit cards tend to negatively affect your credit score). Paying off debt and not opening new credit card accounts may also help your score.
The Bottom Line
Home ownership is possible, and your credit score is an important factor when it comes to determining your mortgage interest rate. Aim for the highest credit score possible, and your mortgage terms are likely to be more favorable. Good luck.