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Anyone who’s exploring homeownership may know that rising interest rates and elevated home prices are making that goal challenging.
The average rate on a typical 30-year, fixed-rate mortgage has been zigzagging between 6% and 7% for the last several months — down from above 7% in early November but roughly double the 3.3% average rate heading into 2022, according to Mortgage News Daily.
Yet the interest rate that any particular buyer is able to qualify for depends at least partly on their credit score — meaning you have some control over whether you’re able to get the best available rate, experts say. And the difference that a good or excellent score makes in terms of monthly payments — and total interest paid while you hold the mortgage — can be significant.
“The score impacts practically everything: loan approval, interest rate, monthly mortgage insurance premiums … and ultimately their payment,” said Al Bingham, a credit expert and mortgage loan officer with Momentum Loans.
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The median home price in January was about $383,000, according to Redfin. Although prices have been sliding since mid-2022, that amount is still 1.5% higher than a year earlier. In January 2020, the median was below $300,000.
While you may be able to negotiate on the price of the house to bring the overall cost of homeownership down, it’s also worth making sure you go into the process with as high a credit score as possible.
Lenders check three scores but use one number
Although things like steady income, length of employment, stable housing and other aspects of your financial life are important to lenders, your credit score gives them additional information.
The three-digit number — which ranges from 300 to 850 — feeds into a lender’s calculation of how risky a borrower you may be. For example, if you’ve always made your debt payments on time and you have a low credit utilization (how much you owe relative to your available credit), your score will benefit.
And the higher the number, the less of a risk you are to lenders — and therefore the better terms you can get on a loan.
Lenders check a homebuyer’s credit report and score at each of the three large credit-reporting firms: Equifax, Experian and TransUnion. For mortgages, the score provided by those companies is typically a specific one developed by FICO, because it is the score currently relied on by Fannie Mae and Freddie Mac, the largest purchasers of home mortgages on the secondary market. (In the coming years, this reliance on one score is poised to change.)
However, because that particular FICO score can differ among the three credit-reporting firms due to differences in what is reported to them and the timing, mortgage lenders use the middle number to inform their decision.
The higher your score, the lower the interest rate you’ll be charged. For illustration only: On a $300,000, fixed-rate 30-year mortgage, the average rate is 6.41% (as of Thursday) if your credit score is in the 760-to-850 range, according to FICO.
This would make your monthly principal and interest payment $1,878. On top of this amount typically would be property taxes, homeowners insurance and, if your down payment is less than 20% of the home’s sale price, private mortgage insurance.
In contrast, if your score were to fall between 620 and 639, the average rate available is 7.99%. That would mean a payment of $2,201 (again, for principal and interest only).
Most of your monthly payment goes to interest at first
Because of how loans are structured, most of your monthly payment would go to interest at the beginning of the loan instead of toward the principal.
For example, if you started paying on that $300,000 mortgage next month with a rate of 6.41%, in two years you would have paid $39,600 in interest and just $7,438 toward the principal, according to Bankrate’s mortgage calculator.
In comparison, a rate of 7.99% would mean that in two years, you would have paid $49,570 in interest and $5,455 toward the principal, according to the Bankrate calculator.
There are ways to boost your credit score
If you want to get your score up before applying for a mortgage, there are some key things you can do.
“Improving your credit score really comes down to the fundamentals,” said Ted Rossman, senior industry analyst for Bankrate. “You should aim to pay your bills on time, keep your debts low and show that you can successfully manage a variety of types of credit over the long haul.”
And, he said, there are some things you can do to improve your score fairly quickly.
“My favorite is to lower your credit utilization ratio,” Rossman said, referring to credit card balances. “This resets every month and it typically reflects statement balances, so you might have a high utilization ratio even if you pay your credit cards in full to avoid interest.”
You may want to consider making an extra mid-month payment or asking for a higher credit limit to bring the ratio down, he said.
“It’s often recommended to keep [the ratio] below 30%, although below 10% is even better, and your credit score should improve as long as you bring it down,” Rossman said.
He also recommends checking your credit report — which you can do for free at annualcreditreport.com — before applying for a mortgage. “Look for any errors and correct them as soon as possible,” he said.
