You’ve probably gotten emails from financial institutions offering you a free peek at your credit score – an offer that’s one more way to attract consumer interest in new credit-related products, such as credit cards.
But your credit score is much more than a marketing tool. In fact, it plays a major role when applying for what amounts to one of life’s biggest financial commitments – a home mortgage.
It’s been that way since the late 1990s, consumer credit expert John Ulzheimer tells Bankrate.com, when the Federal Housing Finance Agency mandated the score’s use as part of the mortgage application process. In fact, says Ulzheimer, the score has become “as important as a solid appraisal and having sufficient income.”
The highs and lows of FICO
Most institutions use a score based on the Fair Isaac Corporation model. Known as a FICO score, this metric pegs consumer creditworthiness on a scale ranging from 300 to 850 points, with higher numbers indicating better credit. An “excellent” score on the scale falls at around 750; the national average near the end of 2017 came in at around 700, says Ulzheimer.
What does that mean when applying for a mortgage loan? Two things, mainly.
First, different scores are required to qualify for different kinds of loans. According to Lendingtree.com, the typical minimum score needed to gain approval for a Conventional home loan – the kind that most Americans want, usually repaid over either 15 or 30 years – is 620.
By contrast, a loan insured by the Federal Housing Administration (FHA) can regularly be secured with a FICO score of 500. And those who qualify for a loan through the Veterans Administration (VA) don’t need a minimum score; in those cases, the entire loan profile is taken into consideration.
Second, and more importantly as far as most consumers are concerned, your FICO score can dictate how much house you can actually afford to buy.
Those numbers behind THE number
That’s because your FICO score influences the loan percentage rate you’ll be offered, since applicants with lower scores are generally viewed as being at a higher risk for missing payments or, in some cases, defaulting on the loan entirely. While a fraction of a percentage point difference might not seem like a big deal when applying for a loan, the amount paid in interest over a period of many years can quickly add up.
For example, a $200,000 Conventional 30-year mortgage taken at 4.5% will generate interest payments totaling $164,813. A better credit score resulting in an improved rate of, say, 4.25% on the same loan and repayment period would rack up interest charges of $154,197 – a $10,000 savings, thanks to keeping a healthier FICO score.
Using the same model, the difference in loan rates also means that the total monthly principal and interest payment goes from $1013 on the higher-rate loan to $984 on the lower-rate one. And if your monthly housing charges are already pushing the limits of what a lender will allow, based on commonly accepted ratio calculations, then the higher your FICO score, the better.
This is because lenders generally prefer a “28 over 38” ratio, which simply means that your total housing payment doesn’t exceed 28% to 33% of your gross monthly income, while your total monthly debt obligations don’t exceed 38% of the same gross monthly income figure. Lenders will sometimes exceed these numbers, says Credit Sesame, if the applicant demonstrates strong “offsetting factors,” such as a larger down payment or…you guessed it, a top-notch FICO score.
Speaking of down payments, lower FICO scores can result in lenders requiring more of one so that the lender’s risk is minimized in the event that there are problems repaying the loan. This means that a home buyer might have to lower their expectations about the kind of home they can buy, since more money would be needed for a down payment, leaving less for renovations, repairs, furnishings, or upgrades.
Keeping it soft keeps it clean
So, other than paying your bills on time every month, and keeping your debt numbers low, what other factors can influence your credit score?
Credit scoring expert Tom Quinn, writing at the blog of FICO itself, explains that consumers need to understand the difference between what are known as soft and hard inquiries.
Hard inquiries occur when you actually apply for credit, whether for an auto loan, a mortgage, or in response to a “pre-approved” credit card offer.
Soft inquiries, on the other hand, happen when your credit report has been accessed, like when you ask for a free copy of your credit report, but not because you have applied for credit.
Having too many hard inquiries can lower your FICO score because they indicate that you are applying for increasing amounts of debt.
In short, keeping a healthy FICO score provides access to the most preferable rate terms while also ensuring that you can get the most house – including desired improvements – for your money.