What Does a Credit Score Mean for a Mortgage?

What does a credit score mean for a mortgage? Credit scores are a critical component of the home buying process. You may ask, what is a credit score? Simply, it is a number assigned to a person that is an indicator of that person’s ability to repay a loan. Theoretically, the better the credit score, the more likely the individual is to repay the loan and the lower the risk to the lender; thus a lower interest rate. Wondering what is a good credit score? Click here: https://www.experian.com/blogs/ask-experian/credit-education/score-basics/what-is-a-good-credit-score/ In fact, when a borrower is applying for a mortgage, the mortgage company will pull a tri-merged credit report (a credit report including data from all three of the major credit repositories: Trans Union™, Experian™, and Equifax™.) With these scores in hand, the mortgage company will use the middle of the three scores for all purposes of the buyer’s loan.

What happens when an individual buys a home?

The example below identifies credit report information for a transaction with one buyer. The three scores for this person appear below, with a high score of 765, a low score of 718 and a middle score of 753. Consequently, 753 is the score that will be used.

What happens when two or more people buy a home together?

buying a home in florida — Sale image created by Xb100 – Freepik.com

In addition, when there are two or more borrowers on a loan, the bank will use the lowest middle score of the borrowers. Here is an example:

A husband and wife are purchasing a home together. The wife has a credit score of 790, 789 and 807. Her middle score is the 790. The husband has a credit score of 689, 672 and 695. His middle score is the 689. Therefore, for the purposes of this loan, the lender is required to use the husband’s credit score for the family’s purchase, as he holds the low middle score.

How important is a credit score?

Having a great credit history is extremely important to the mortgage process. The higher the credit score, the better the terms the buyer will receive from the bank. Two main factors that credit scores affect are a buyer’s interest rate and the buyer’s mortgage insurance (when applicable).

Below is an illustration of the effects of having a great credit score compared to a poor credit score. In this example, one buyer has a credit score of 740 and the second a credit score of 640. We are assuming that the buyer is utilizing a conventional loan program and is putting 5% down on a $300,000 purchase.

Credit Score	740	640	Difference
Rate	4.125%	4.75%	.625%
Monthly P&I	$1,381	$1,487	$106 per month
Monthly PMI	$140.13	$356.25	$216.12 per month

**Monthly P&I stands for Monthly Principal and Interest & Monthly PMI stands for Monthly Private Mortgage Insurance**

The buyer with the 740 credit score will have a monthly payment of $1521.13, which is $322.12 ($106 + $216.12) less than the buyer with the 640 credit score whose monthly total would be $1843.25.

How an FHA Loan Can Help

Buyers with lower credit scores typically purchase homes with FHA loans primarily because FHA requires all buyers to carry mortgage insurance at a cost of .85% (when putting down less than 10%). A credit score is not a factor when determining the cost of the mortgage insurance on an FHA loan. In addition, mortgage insurance is less expensive for buyers with a lower credit score (in comparison to standard conventional loans), so the interest rate will be a little bit better for the lower credit score buyers. Let’s take a look at the cost differences. This is assuming the buyer is utilizing FHA financing and is putting down 3.5% on a $300,000 purchase. Also, this example is 3.5% down, the other two are 5%. It may make sense to use the same metrics for all three examples so the reader gets a true picture of the difference.

Credit Score	740	640	Difference
Rate	4.25%	4.49%	.24%
Monthly P&I	$1,424	$1,465	$41 per month
Monthly PMI	$205.06	$205.06	$0 per month

**Monthly P&I stands for Monthly Principal and Interest & Monthly PMI stands for Monthly Private Mortgage Insurance**

The buyer with the 640 credit score is only going to pay $41 more per month than the buyer with the 740 credit score for the FHA loan. For more information on FHA loan requirements click here https://www.fha.com/fha_loan_requirements

What are specialty programs?

When working with a lender you always want to make sure they are checking to see if you qualify for any specialty programs. The Fannie Mae Home Ready program & the Freddie Mac Home Possible program are two programs that allow buyers to purchase with a conventional mortgage with less emphasis on your credit score. Let’s take a look at a buyer with a 700 credit score who is putting 5% down on a $300,000 purchase.

Program	Home Ready	Traditional	Difference
Rate	4.125%	4.375%	.25%
Monthly P&I	$1,381	$1,402	$42 per month
Monthly PMI	$178.73	$206.63	$27.90 per month

**Monthly P&I stands for Monthly Principal and Interest & Monthly PMI stands for Monthly Private Mortgage Insurance**

In this scenario, a buyer who takes advantage of the Home Ready loan compared to going with the traditional conventional mortgage will save $69.90 each month.. Be sure that you are working with a mortgage specialist who exhausts all options to save you money.

How can you maximize your credit score?

Maximizing your credit score is critical in maintaining your long-term financial health. A good credit score can save you significant money over the course of your life. Below are a few tips to maintaining a good credit score (or raising one that may be “not so good”)!

Always pay your bills on time. Consider setting up Autopay to eliminate human error!
Keep your monthly credit card balances at 30% or lower than your credit limit!
Do not close out credit cards – your score will increase when you have established older, established accounts.
Do not get in over your head. Be smart, if you cannot afford it, don’t buy it!