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Good credit can be important for many reasons―but it's especially critical when you're looking for a mortgage. A higher credit score could mean saving hundreds of dollars on your monthly payment and tens of thousands over the lifetime of the loan.
How Do Mortgage Lenders Determine Interest Rates?
Mortgage lenders consider many factors when deciding whether you can qualify for a mortgage and the interest rate to offer. Your interest rate will have a large impact on the total you'll pay over the mortgage's term and is a key factor that could save you money on your loan costs. Your rate could depend on your:
- Credit score: A high credit score can help you get a lower interest rate. FICO Scores, the credit scores used by 90% of top lenders, range from 300 to 850, but you don't need the highest score to get the best rates. Once your credit score is in the high 700s, you might qualify for a lender's best-advertised rates if you also meet their other requirements.
- Down payment: A larger down payment could also lead to a lower interest rate. If you can put at least 20% down, you'll also avoid paying for mortgage insurance.
- Debt-to-income ratio: Your debt-to-income ratio (DTI) depends on your monthly income and debt payments. A lower DTI might help you qualify for a lower interest rate. Keep in mind, your income doesn't appear on your credit report, so the lender calculates DTI separately.
- Loan type: There are many types of mortgages, including conventional loans and government-backed FHA loans, VA loans and USDA loans. While government-backed loans might offer lower rates, they could require fees or insurance that increase your total cost.
- Loan size, term and rate type: Your mortgage amount, repayment term and type of interest rate (fixed or adjustable) could all impact your offer. Generally, you can get a better rate with a loan that isn't especially small or large, and if it has a shorter term. An adjustable-rate mortgage may start with a lower rate but increase in the future, while a fixed-rate mortgage is locked in at the same rate for the life of the loan.
- Discount points: You may be able to buy points and pay higher closing costs to lock in a lower interest rate.
- Location: The home's location can also impact mortgage rates, but it might not vary much unless you're looking at homes in different states or metro areas.
There are also some factors that can impact mortgage rates but are completely out of your control. For example, rising interest rates and inflation could lead a mortgage lender to change its offers. Your rate can also vary depending on the lender.
How Much Can a Good Credit Score Save You?
A good credit score doesn't guarantee that you'll get approved for a mortgage or receive the best rates, but it can help. And because mortgages are typically large loans, even a small change in your interest rate could save you a lot of money on your monthly payment and how much interest you pay overall.
Cost of a 30-Year Fixed Mortgage Based on Your Credit Score
Looking at the national average mortgage rates, your annual percentage rate (APR) could vary by over 1.5%, and a high credit score could help you save about $100,000 overall. The results assume you put 20% down and took out a $300,000 mortgage with a 30-year term and fixed interest rate.
Source: myFICO. Based on national average rates as of March 2022.
How to Improve Your Credit Before Getting a Mortgage
Improving your credit can take time, and the specifics will depend on your unique credit profile. In general, having a long history of making on-time payments can help set you up for getting a mortgage with favorable terms. If you're looking for a mortgage or plan to start house hunting soon, you may want to:
- Check your credit score. Mortgage lenders may pull three credit reports and credit scores, one each from Experian, TransUnion and Equifax, and use the middle score. Most mortgages rely on specific FICO® Score models. You may need to pay to check these scores, but you can get a FICO® Score 8 for free from Experian to give you a general idea of where you're at.
- Don't miss a payment. Missing a debt payment can hurt your credit score, and the impact may be greatest when you first miss the payment. While looking for a home can be stressful, make sure you don't accidentally forget to make any credit card or loan payments.
- Pay down credit card balances. Paying down credit card debt can lower your credit utilization ratio, or amount of available credit you're using, which might quickly improve your credit scores.
- Pay off past-due accounts. Unpaid collection accounts could impact your ability to qualify for a mortgage. And while newer scoring models ignore paid-off collection accounts, the credit scores mortgage lenders generally use don't. Still, showing you paid off past-due accounts is better than ignoring them.
Get Started Now to Maximize Savings
Ideally, you can start working on your credit months in advance to net as much in savings as possible with a boosted credit score. But there are also some last-minute moves that can help, such as lowering your utilization rate. Even then, it could take a month or longer for your new balance to be reported to the credit bureaus and impact your scores. If you're in the midst of closing on your loan, ask your lender about requesting a rapid rescore to have the new information added to your credit report right away.