NEW YORK (MainStreet) — So you’ve found your dream home, figure you’ll stay long enough to make buying pay off more than renting and spotted a mortgage with an attractive low rate. Nothing could possibly stop you from moving, right? Wrong: A mortgage denial could.
In the wake of the credit crisis, lenders remain skittish, turning down applicants who would have sailed through the approval process just a few years ago. Even if you can get a loan today, anything you can do to boost your credit score will help reduce your loan rate so you can get the best deal possible.
A top-level FICO score of 760-850 could earn you an interest rate of 4.267% on a 30-year fixed-rate mortgage, according to FICO, the main credit rating agency. A score of 660 to 670 would likely get you a rate of 4.88%, while you’d pay a real premium, 5.856%, with a score of 620 to 639.
These differences add up. For every $1,000 borrowed, you’d pay $4.93 a month at 4.267%, or $5.90 at 5.856%, according to the BankingMyWay Mortgage Loan Calculator. On a $250,000 loan, the lower rate would save you about $29,000 during the next 10 years, which isn't small potatoes.
Experts caution against pulling too many “hard inquiries,” or requests for your credit score from a lender. Asking multiple mortgage lenders to pre-approve your loan, for example, could chip away at your credit score, because the system assumes those looking to increase their debt are far less likely pay it off. If you request the credit score yourself, rather than letting a lender do it for you, however, you won’t be penalized. Odd, but that’s how the system works.
It’s best, therefore, to polish your record, then go after the most appealing loan you’re likely to get. The lender should be able to tell you the minimum FICO score required for a given loan.
Start by checking your credit history with the three ratings agencies. Check them all for free at one time using annualcreditreport.com. The site has instructions for correcting errors, and in addition to your full report, you can get your credit score from FICO. Right now you can do this for free by signing up for Score Watch, a credit monitoring service, and cancelling the service within 10 days.
In the weeks and months preceding your mortgage application, be religious about paying all bills on time. Recent delinquencies hurt your score more than ones well in the past.
It also helps to reduce your debts by paying off credit card balances, auto loans and anything else you can afford to get rid off before shopping for a home. Any extra money you throw at your debt now can save you a bundle if it helps you get a lower mortgage rate. Jack M. Guttentag, an emeritus finance professor at the Wharton School of Business, writes on his website that it’s best to start with loans from the “wrong lenders” – those that hurt your score the most.
“Because finance companies lend to relatively poor risks, the credit score of any borrower owing money to a finance company is lower than it would be if the creditor was a bank,” Guttentag writes. “By the same logic, borrowers who have credit cards of department stores are penalized, relative to what their score would be if they had cards issued by banks.”
Revolving debt, like credit cards and home equity lines of credit, is more damaging to your score than debt of an equal size in a fixed-rate installment loan like a car loan, Guttentag writes, because interest rates can rise on revolving debt, causing payments to shoot up, and teh borrower to become a bigger default risk.
Since many of us find it difficult to clear out all out debt over a short period of time, it clearly pays to focus on debts that can do the most damage to your credit score. Doing this will help you land that low mortgage rate, which will in turn help you land your dream home, and make the whole thing cheaper down the line.