Your credit score dictates your interest rate. In general, the higher your score, the lower your rate. The lower your score, the higher rate you get. Lenders use your credit history and score as a way to determine your risk level. Late payments, collections, and defaulted accounts all decrease your score and make you a high risk.
If a lender decides to give you a loan even with a lower score, they need to make up for that risk. Many lenders charge a higher rate to make up for it. They may also charge more fees on the loan. For example, you may pay an origination fee if your score is too low. Lenders use this as ‘prepaid interest.’ It’s money they make upfront. If you were to default, they at least have the money you paid up front to fall back on.
What’s a High Credit Score?
Here’s where things get difficult. There is no cut and dry answer regarding what credit score is considered high. Every lender has a different take on this. One lender may require credit scores as high as 740 in order to secure the best interest rate. Others may allow lower scores. There are no regulations regarding this – it’s literally up to each lender.
How Much Can Interest Rates Vary?
You might not think it’s a big deal to have the ‘best’ interest rate. How much could the rates really vary? In reality, you could see rates differ as much as 1 ½% from the highest and lowest credit scores. Putting that into perspective, let’s look at a $150,000 mortgage.
- Borrower A has a 740 credit score and secured a 4.5% rate. Her principal and interest payment equals $760.
- Borrower B has a score of 620 and secured a 6.0% rate. Her principal and interest payment equals $899
That’s a difference of $139 per month or $1,668 per year. If both borrowers kept the loan for the full 30 years, Borrower A would pay $50,040 less than Borrower B. That’s the importance of a good credit history.
What Else Lenders Look at On your Credit History
Your score is not the only thing lenders focus on when looking at your credit report. The score may be the first thing they look at because it lets them know if your file is worth processing. However, once they get past the score, they look at other factors as well:
- A good mixture of account types – If you have a lot of revolving credit, you might be a higher risk. Lenders like to see borrowers that have a mixture of installment debt and revolving debt.
- Low balances on your revolving debt – You have credit limits and available balances. If your available balance is too low, it means your credit utilization rate is too high. In other words, keep your credit card balances as low as possible. Aim for 30% or less of your credit line.
- Age of credit – The older your credit accounts, the better. It gives the lender a better idea of how you handle your credit over a long period. If too many of your accounts are too new it can be hard for a lender to judge your risk level.
- Number of inquiries – If you have too many inquiries on your credit report, you might have new accounts open. Even though they aren’t on your credit report yet, they still affect your chances of getting a mortgage. Don’t apply for any new credit within a few months of applying for a mortgage for the best results.
Fixing Your Credit Score
What if you find out you have a low credit score? Are you stuck with that high interest rate? Luckily, there are things you can do. First, you must withdraw your mortgage application. Talk to the loan officer to see what score they would like to see from you to give you a better rate. Next, you can set out to secure that score. Here’s how:
- Bring your payments current – Late payments hurt your credit score a lot. Bring all accounts current and then continue to make your payments on time. The more on-time payments you have, the more your score will increase.
- Fix mistakes – You might be surprised to learn how many mistakes are on your credit report. Go through it with a fine-toothed comb determining what is right and what is an error. Then set out to fix the errors with both the credit bureau and the company reporting the error.
- Lower your credit utilization rate – Again, the amount of revolving credit you have outstanding determines your credit score. If your utilization rate is too high, pay some of your debt off and allow your score to increase.
Your credit score has a large impact on your mortgage interest rate. You’ll need to talk to your loan officer to see how your score affects your rate. If you don’t like the rate you are provided, you can do one of two things. You can shop around with other lenders to see if someone else will give you a lower rate. You can also withdraw your application and work on your credit. The higher your score, the better the rate you’ll get, no matter which lender you choose in the end.