Credit and Mortage, Loans
When you’re applying for a mortgage, your credit score has the most meaningful impact on the rates you’ll be offered. Typically, the higher your score, the lower the interest rates you’ll be offered by lenders.
“Credit scores are enormously influential in the mortgage process and they have been since the [Federal Housing Finance Agency] essentially forced the mortgage world to start using them in the late 90s,” says John Ulzheimer, author of “The Smart Consumer’s Guide to Good Credit.” Ulzheimer says credit scores are “as important as a solid appraisal and having sufficient income.”
Check your score for free to see where you stand.
What score will get the best rates?
Most credit scores use the Fair Isaac Corporation (FICO) model, which grades consumers on a 300- to 850-point range, with a higher score indicating lower to risk to the lender. Generally, a score of around 750 or higher on the FICO scale is considered an excellent score.
“I’ve talked to people who are keenly aware of their score but are hard-pressed to tell me what that means in terms of what they qualify for,” says Bruce McClary, spokesman for the non-profit National Foundation for Credit Counseling.
Although it’s up to the specific lender to determine what score a borrower needs to be offered the lowest interest rates, the difference of a few points on your credit score can affect how much your monthly payments would be by hundreds of dollars.
“The good news is there are published interest rates for people who have scores as low as 620, which is about 80 points below the national average,” says Ulzheimer. Use a loan comparison calculator to see how much of a financial impact a loan at varying interest rate points can have on your monthly costs.
For example, a 30-year $200,000 loan at a 4 percent interest rate without any other fees would mean you’d have monthly payments of approximately $954.83. But take out a 30-year $200,000 loan at a 5 percent interest rate and your monthly payments will jump up to $1073.64. Raise that interest rate to 8 percent, and you’re looking at $1,467.53 every month. Credit and Mortage, Loans
Boost your score
If your credit score isn’t great, there are still options. Instead of just settling for the mortgage rates you’re currently qualified for, there are steps you can take to help to revive your score and improve your options.
Most importantly, get a copy of your credit report and review it carefully for any errors. Sometimes simply correcting mistakes can help improve your score.
McClary also advises that as you start shopping around for a mortgage, you hold off on opening any new lines of credit.
“With a lot of inquiries, the combined effect could be enough to bring your score down. Even a small drop in your credit score could have an impact on the rates you’re qualified for,” says McClary.
If you decide to do some rate-shopping, try to compare lenders within 30 days of when you think you’re ready to pull the trigger on a loan. According to FICO, they won’t count against your score any mortgage or auto loan inquiries made within 30 days of when they generate a credit report for a lender.
What are (discount) points and lender credits and how do they work?
Generally, points and lender credits let you make tradeoffs in how you pay for your mortgage and closing costs. Points, also known as discount points, lower your interest rate in exchange paying for an upfront fee. Lender credits lower your closing costs in exchange for accepting a higher interest rate.
These terms can sometimes be used to mean other things. “Points” is a term that mortgage lenders have used for many years. Some lenders may use the word “points” to refer to any upfront fee that is calculated as a percentage of your loan amount, whether or not you receive a lower interest rate. Some lenders may also offer lender credits that are unconnected to the interest rate you pay – for example, as a temporary offer, or to compensate for a problem.
The information below refers to points and lender credits that are connected to your interest rate. If you’re considering paying points or receiving lender credits, always ask lenders to clarify what the impact on your interest rate will be.
Points Credit and Mortage, Loans
Points let you make a tradeoff between your upfront costs and your monthly payment. By paying points, you pay more upfront, but you receive a lower interest rate and therefore pay less over time. Points can be a good choice for someone who knows they will keep the loan for a long time.
Points are calculated in relation to the loan amount. Each point equals one percent of the loan amount. For example, one point on a $100,000 loan would be one percent of the loan amount, or $1,000. Two points would be two percent of the loan amount, or $2,000. Points don’t have to be round numbers – you can pay 1.375 points ($1,375), 0.5 points ($500) or even 0.125 points ($125). The points are paid at closing and increase your closing costs.
Paying points lowers your interest rate relative to the interest rate you could get with a zero-point loan at the same lender. A loan with one point should have a lower interest rate than a loan with zero points, assuming both loans are offered by the same lender and are the same kind of loan. For example, the loans are both fixed-rate or both adjustable-rate, and they both have the same loan term, loan type, same down payment amount, etc. The same kind of loan with the same lender with two points should have an even lower interest rate than a loan with one point.
Points are listed on your Loan Estimate and on your Closing Disclosure on page 2, Section A. By law, points listed on your Loan Estimate and on your Closing Disclosure must be connected to a discounted interest rate.
The exact amount that your interest rate is reduced depends on the specific lender, the kind of loan, and the overall mortgage market. Sometimes you may receive a relatively large reduction in your interest rate for each point paid. Other times, the reduction in interest rate for each point paid may be smaller. It depends on the specific lender, the kind of loan, and market conditions.
It’s also important to understand that a loan with one point at one lender may or may not have a lower interest rate than the same kind of loan with zero points at a different lender. Each lender has their own pricing structure, and some lenders may be more or less expensive overall than other lenders – regardless of whether you’re paying points or not. That’s why it pays to shop around for your mortgage. Explore current interest rates or learn more about how to shop for a mortgage.
Lender credits work the same way as points, but in reverse. You pay a higher interest rate and the lender gives you money to offset your closing costs. When you receive lender credits, you pay less upfront, but you pay more over time with the higher interest rate.
Lender credits are calculated the same way as points, and may appear on lenders’ worksheets as negative points. For example, a lender credit of $1,000 on a $100,000 loan might be described as negative one point (because $1,000 is one percent of $100,000). Credit and Mortage, Loans
That $1,000 will appear as a negative number as part of the Lender Credits line item on page 2, Section J of your Loan Estimate or Closing Disclosure. The lender credit offsets your closing costs and lowers the amount you have to pay at closing.
In exchange for the lender credit, you will pay a higher interest rate than what you would have received with the same lender, for the same kind of loan, without lender credits. The more lender credits you receive, the higher your rate will be.
The exact increase in your interest rate depends on the specific lender, the kind of loan, and the overall mortgage market. Sometimes, you may receive a relatively large lender credit for each 0.125% increase in your interest rate paid. Other times, the lender credit you receive per 0.125% increase in your interest rate may be smaller.
A loan with a one-percent lender credit at one lender may or may not have a higher interest rate than the same kind of loan with no lender credits at a different lender. Each lender has their own pricing structure, and some lenders may be more or less expensive overall than other lenders – regardless of whether or not you’re receiving lender credits. Explore current interest rates or learn more about how to shop for a mortgage.
See an example
The chart below shows an example of the tradeoffs you can make with points and credits. In the example, you borrow $180,000 and qualify for a 30-year fixed-rate loan at an interest rate of 5.0% with zero points. In the first column, you choose to pay points to reduce your rate. In third column, you choose to receive lender credits to reduce your closing costs. In the middle column, you do neither. Credit and Mortage, Loans