Interest paid on a mortgage can add up to hundreds of thousands of dollars over the life of the loan. The most influential determinant of your mortgage rate will be your credit score. The higher your score, the lower the interest rate. On a loan as large as a mortgage, a mere percentage point up or down can add up to a significant amount of money.
Not only are credit scores more vital than ever when it comes to getting a good rate on a home loan, but they will influence whether you can even get a loan at all.
Credit is so tight and lenders are so skittish that buyers below a certain threshold, typically a FICO score of 620, have a better chance of striking oil in their bathtub than securing a mortgage. It's possible, but will require some digging.
Standards have not always been so restrictive; the industry has changed in recent years.
"It's changed twofold: First there is a minimum score that you need to have to even be considered for a mortgage regardless of compensating factors such as your income and your assets. And unless you have top-tier credit, you're not going to qualify for the best programs, terms and conditions," says Louis Spagnuolo, vice president of mortgage banking at WCS Lending in Boca Raton, Fla.
Though the tiers go up all the way to 850 on the FICO scale, a score of 740 or more should qualify for the best mortgage rates from most lenders. Depending on the lender, the mortgage rates offered to the highest and lowest credit tiers can vary as much as a full percentage point and a half, says Spagnuolo.
What lenders look for
In general, investors demand higher yields from risky investments. This applies in the mortgage lending arena. Lenders assign you a rate that matches the gamble they're taking in lending you money.
Lenders prefer borrowers with low balances, a long history of on-time payments and a mix of credit utilization -- for instance, a car loan and a couple of revolving accounts such as credit cards.
"Lenders look at several variables on the credit report: outstanding debt; the outstanding debt relative to the total available debt; the length of the credit history and the pursuit of new credit -- how many inquiries are on your report," says Matt Hackett, underwriting manager at Equity Now, a direct mortgage lender in New York.
Some types of credit may be viewed more negatively than others, particularly if there's not a healthy mix of available credit and loans on your report.
"Store cards are looked on more negatively. Lenders just don't like to see them," Hackett says.
Curtis Arnold of CardRatings.com says that while a store card won't adversely affect your score, if a lender manually looks at your report there may be a subjective view that store cards are less desirable than a major credit card.
Clean up your credit
Whether you believe your credit report to be pristine and unmarred by financial indiscretions, the ideal time to check it out for yourself is up to a year before buying a home.
Go to AnnualCreditReport.com to get your yearly free credit reports from Experian, TransUnion and Equifax. Make sure you get reports from all three. The information they contain can vary wildly.
The credit reporting agencies do charge a fee if you want to know your credit score. Lenders look at all three scores and use the middle one, according to Hackett.
Consumers should be on the lookout for any information that doesn't belong on their credit report or that is incorrect. In 2007, a survey by Zogby found that 37 percent of consumers find errors when they check their credit reports.
Scour everything from the way your name is spelled and previous addresses to checking that each and every account is yours and reported correctly.
"Sometimes people will quickly glance over their information and that's it. But you should take the time and look at the account numbers," says Steve Katz, consumer communications director for ZenDough.com, the consumer personal finance site by TransUnion.
What else you can do
If you're thinking of buying a home in the near future, try not to apply for new credit. Though it's not always avoidable -- for instance, if you need a car loan or college financing -- you should resist opening several new lines of credit at once.
"A couple in a year is fine. Four or five in a year will start to have an impact. The best way to think of it is that you don't want to appear credit hungry, so you don't want to apply for a lot in a short period of time," says Katz.
The typical range is 1 percent to 3 percent of the home loan amount, expressed as percentage points.
Another way to get a premium interest rate is with a big down payment. Understandably, banks feel less jittery about your prospects of defaulting on the loan with a down payment of 25 percent or more.
"The down payment is the second most important criteria after your credit score because that is one of the mechanisms the bank uses to gauge how risky the loan is," says Spagnuolo.
"If you put down 40 percent, a lot of the banks will give preferred interest rates for that," he says.
Transforming your credit report won't happen overnight, but with time and consistency anyone can get to the elite levels of mortgage pricing and save a ton of money in the long run.