How Does Credit Score Affect Mortgage Rates?
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Credit Scores and Mortgage Rates
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Lenders like to give out loans -- it's how they make their money. But a mortgage lender, or the ultimate owner of a mortgage, only profits if the borrower is able to pay back the full principal plus interest. As a result, lenders prefer to lend to those who can most easily pay back the debt, and they will offer preferential terms such as low mortgage rates to attract business. To gauge the relative likelihood that any given borrower will be able to make good on the debt, mortgage lenders obtain their credit score and credit history. Borrowers with a low credit score represent a higher risk and, therefore, lenders charge higher interest rates to help protect themselves from loss.
About FICO
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Several factors contribute to an individual FICO credit score, and mortgage lenders find that these factors relate directly to the risk involved with financing that individual's home mortgage. Delinquency, which relates to whether a person makes regular credit payments on time, accounts for more than a third of the total credit score. Clearly, if the borrower is already unable to meet the minimum payments on their credit lines, then lending them more money is probably not a good idea. The amount of outstanding credit they have relative to their income is another major determinant of a credit score. The more debt a person already has, the less likely that they'll be able to responsibly take on new debt.
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Crunching Numbers
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Mortgage rates determine the monthly payment due on a mortgage and, along with the term of the loan, the total amount that has to be repaid over and above the principal. An individual with a high credit score will benefit directly by receiving a lower interest rate, which translates into lower monthly payments and less cost overall. The highest FICO scores, between 760 and 850, can be offered an interest rate as much as 25 percent lower than those with a credit score between 620 and 640 -- as an example, 4.658 percent versus 6.247 percent. On a 30-year loan of $300,000, this translates to $300 in savings each month and a total of $108,000 over the life of the loan. In practical effect, however, even though the second borrower would have to pay significantly more to purchase the same house, an applicant with a lower credit score might not receive a loan offer at all.
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