How Credit Scores Affect the Homebuying Process
When homebuyers apply for a mortgage, lenders immediately want to know their credit score but it is not just for qualification purposes. These scores play an important role in many different aspects of the homebuying process from setting interest rates to determining insurance premiums. Learning about the role of credit scores can help homebuyers confidently compare mortgage terms—and this guide is here to help.
Minimum Credit Scores Apply
Lenders have many mortgage types for homebuyers to consider and each has their own minimum credit score limits. To acquire a conventional loan, homebuyers need to have a credit score of 620 or above to even begin the qualification process. USDA loans have an even stricter requirement of 640 and above, while FHA loans are open to those with credit scores as low as 580. Lenders can help loan applicants find mortgage programs that work with their credit scores or provide advice on how to raise those scores before applying.
Higher Scores Equal Lower Interest Rates
When applying for a loan, the credit score of each applicant factors into the interest rate offered by the lender. With a low credit score, interest rates could increase by half a percent or more, driving up the total monthly payment amount as well. The high interest rates also increase the total amount paid over the entire life of the home loan.
Homebuyers can save themselves a significant amount of money each month and throughout life by increasing their credit scores before applying for a home loan. In some locations, lenders allow homebuyers to pay points to lower their interest rate. The total number of points paid is based on the applicant's credit score and their ideal rate figures, so it can still prove costly.
Loan Amounts Depend on Credit Scores
The total amount homebuyers can borrow is also dependent on credit scores. Using credit scores, income, and other important factors, lenders determine the total loan-to-value (LTV) ratio homebuyers qualify for at that time. This figure represents the total percentage of the sales price of the property that applicants can borrow. With a high credit score, applicants might qualify for an LTV of up to 95 percent, while lower scores can decrease this percentage considerably. In fact, credit scores lower than 650 can decrease the allowed LTV to 80 percent instead.
Down Payment Requirements Vary as Well
Although it is rarely necessary to pay a 20 percent down payment anymore, low credit scores can increase the amount homebuyers have to put down. This is especially true if their scores dropped their loan-to-value ratio below the expected percentage. Low scores can also keep homebuyers from participating in certain programs that have low down payment requirements.
Lower Credit Scores Can Increase PMI Premiums
Even after affecting so many mortgage loan terms, low credit scores can also have an impact on private mortgage insurance premiums. Like the lenders, mortgage companies use risk-based pricing models that increase rates in response to financial missteps. Since the PMI premiums can remain static across the life of the loan, it is important to resolve this issue before moving forward in the purchase process—or prepare to pay more for years to come.
How Homebuyers Can Build Their Credit Scores
Since credit scores play such an important role in the homebuying process, it is important to resolve issues that are keeping them low before filling out the mortgage loan application. Although it can take some time to repair low credit scores, it is well worth the investment, as it can pay off big time in the long run.
Before starting the improvement process, it is important to check that all information on the credit report is accurate. If there are any mistakes noted, the error correction process should begin at once. They can correct these errors by sending a message to the lender and reporting their mistake. They will perform an investigation and verify the mark is accurate or remove it altogether.
With that done, homebuyers can start improving their credit scores by ensuring all their monthly bills are paid on time and in full. These on-time payments go a long way in improving credit scores within a short period of time. If they have debt, paying that down is a great next step. For credit cards, they should work on getting their debt balances to 30 percent of the credit limit or even lower.
Depending on their starting score, Eagle Ridge new home buyers can expect the credit repair process to take at least six months. Their efforts will save them an immense amount of money in the future, however, so it is well worth the time and effort.