Credit Scores: How They Can Affect Your Mortgage Rate

Credit scores help determine whether you qualify for a mortgage loan, and if so, what interest rate the lender will charge you.

Your interest rate determines what your monthly payment will be, how much of that payment goes towards interest vs, principal, and how quickly you can build equity in your home. A high credit score can save you money on your mortgage loan, or it could even enable you to qualify for a larger loan and larger home value.   

What credit score do mortgage lenders use?

When you apply for a mortgage, lenders will generally request all three of your credit reports (one from each credit bureau) and a FICO® Score based on each report.  FICO® created different scoring models for each credit bureau—Experian, TransUnion, and Equifax.

The commonly used FICO® Scores for mortgage lending are:

  • FICO® Score 2 or Experian/Fair Isaac Risk Model v2
  • FICO® Score 5 or Equifax Beacon 5
  • FICO® Score 4 or TransUnion FICO® Risk Score 04

Mortgage lenders will often get a single report that contains your credit reports from each of the three credit bureaus and the associated FICO® Scores. It may base the lending decision on your middle credit score or if you're applying jointly with a partner, the lower middle score.

These types of FICO® Scores are all older versions, due to guidelines set by government-backed mortgage companies Fannie Mae and Freddie Mac.  

Mortgage lenders have more flexibility to use different credit scoring models for loans that aren't secured or bought by Fannie Mae or Freddie Mac.

The FICO® Score versions used in mortgage lending, and the more recently released versions, such as FICO® Score 9 and 10, have the same 300 to 850 range.  VantageScore, a competing maker of credit scores, also uses that range for its latest VantageScore 3.0 and 4.0 model credit scores.

What does the credit score measure?

Your credit score is a three-digit number, typically ranging from 300 to 850, that's used to predict the likelihood that you'll pay your credit obligations on time. The credit score gives a snapshot of how reliable you are as a borrower, which lets lenders know whether you are a good risk or not for a loan or credit card. Because some parts of your bill-paying history are more important than others, different pieces of your credit history are given different weights in calculating your credit score.

Even though the specific equation for coming up with your credit score is proprietary information owned by FICO, we do know what information is used to calculate your score.

What makes up your FICO credit score?

  • Payment history - 35%
  • Amounts owed - 30%
  • Length of credit history - 15%
  • Credit mix - 10%
  • New credit - 10%

Why do lenders change rates based on credit scores?

Mortgage rates are determined based on a concept known as risk-based pricing. That means that lenders will increase the rate they charge the borrower based on the amount of negative information contained in your credit profile. The increased rate is supposed to offset the costs the lender is more likely to incur in servicing your mortgage, such as those that might result from missed payments and default proceedings. For example, if your score indicates there is a 10% higher probability the lender will lose 10% on the loan, it could increase your effective rate by 1% (10% x 10%) to offset this potential cost.  

Why does my mortgage rate matter?

Your mortgage rate is one of the key components determining your monthly mortgage payment. Your monthly mortgage payment in an amortizing loan includes both an interest and a principal component. The interest component is compensation to the lender and an expense for the borrower, and the principal component reduces the amount of your mortgage loan, which means more of your home’s value is leftover as your equity stake. For instance, a mortgage calculator can tell you that the monthly payment on a 30-year fixed-rate $300,000 loan with a 3% interest rate is $1,265 per month ($750 interest, $515 principal). If the rate is increased to 4%, the monthly payment increases to $1,432 ($1,000 interest, $432 principal). 

Notice how in this example, the monthly payment increased by $167 overall, of which the interest component actually increased by $250, while the principal component declined by $83. This means that not only are you paying more in interest overall, you are also building equity less slowly because the amount of your payment going towards debt reduction is lower. If you have an interest-only loan, all of your monthly payment is going toward interest, and you can calculate the change in your payment for every change in the rate with a simple formula, i.e., a 1% rate increase on a $300,000 loan will increase the monthly payment by $250 per month throughout the interest-only period.   

What is the typical change in rate for a change in FICO, by type of loan?

In the below example from myFICO.com, the biggest difference in rates occurs at the 640 FICO threshold, where borrowers can save an estimated $94 per month with a 640 vs. 639 FICO. That adds up to $33,840 more in interest payments over the life of the loan for borrowers in the lowest credit score range. Using myFICO.com’s mortgage rate calculator, here’s how much you’d pay at the current rates for each credit score range. These examples are based on national averages for a 30-year fixed loan of $300,000.

mortgage rate calculator screenshot
Source.

Every lender is able to set their own pricing matrix, and each product will have its own pricing matrix as well, so it's best to get actual quotes from different lenders for different products in order to find out how your score impacts your rate for that particular lender’s products. Some products have minimum credit scores, so if your score is below the minimum you won’t qualify for that loan product at all.  

A summary of the credit score ranges for different loan products:

Conventional loans: A score as low as 620 can be permitted but lower scores may come with stricter requirements in other areas, such as higher income.

FHA loans: An FHA loan can be approved for borrowers with a credit score of 500 to 579 with a 10% down payment. Borrowers looking to put as little as 3.5% down will need a minimum 580 score.  

USDA loans: Borrowers generally need a minimum score of 640 to qualify for a USDA loan. In some cases, USDA lenders will consider a lower score with additional analysis of a borrower’s credit.

VA loans: The government doesn’t have a minimum credit score requirement to qualify for VA loans, though many lenders require a minimum score of 620.

Jumbo loans: These loans tend to be the hardest to qualify for if you have a low credit score. Many jumbo lenders require a credit score of at least 720.

READ NEXT: Current Mortgage Rates: US Bankrate Updates | Compare Current Rates

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