By RateMarketplace.com Staff
Humorist Dave Barry once wrote the true measure of a person these days is his or her credit score. That's never been truer than with home mortgage loan rates, which factor heavily on a would-be borrower's credit history and FICO score. This article explains how a person's FICO credit score is calculated, what is considered a good credit score by mortgage lenders, and how your credit score affects the mortgage loan interest rates you can qualify for.
Lenders rely on a mortgage loan applicant's credit score for good reason. The credit score is a number grade on how well borrowers have used and repaid credit in the past. The number gives banks and other lenders rough odds on the likelihood a borrower will make repayments on a timely basis -- or at all. That number and the relative size of a buyer's home loan down payment on a percentage basis lets mortgage lenders set interest rates to correspond to the risk they won't be repaid -- and recoup their money through foreclosure without suffering a loss if they're not.
The most commonly used credit score is the "FICO" from Fair Isaac Corp., which is based on credit data compiled by the three major credit-reporting agencies: Equifax, Trans Union and Experian.
So just what goes into this critically important figure? For many years, Fair Isaac would not disclose the components of its score, which infuriated consumer advocates. They argued that keeping the methodology secret left borrowers with bad credit ratings unable to determine what they needed to address to improve them.
The company now discloses how a person's FICO credit score is calculated and the percentage weight of each factor:
|Length of credit history||15%|
|Types of credit used||10%|
While Equifax, Experian and TransUnion each have their own score for individuals, all credit-scoring systems generally follow number rankings from a low of 300 to a high of 850. At any given time, the average score in the U.S. is about 695.
The lower the credit score, the higher the interest rate the borrower will be charged. The premiums on so-called subprime borrowers can run several percentage points above the best available loan rates. Lenders characterized a score of 600 or lower as "subprime" until the recent housing and mortgage market slump and foreclosure wave, after which some lenders raised the subprime cut-off to 700 or under.
About 60% of Americans recently had a FICO of 700 and over -- and slightly more than 10% scored in the 800-850 range. At the former level, lenders offer more financing options in terms of the types of loans and payback schedules. At the latter, they fall all over each other trying to win those most-creditworthy borrowers' patronage.
In the long run, maintaining good credit is of extreme financial importance because it has a huge influence on long-term borrowing costs. A 100-point difference in a credit score can mean tens or hundreds of thousands of added dollars out-of-pocket over the life of a mortgage loan.
The following example is from MyFICO.com and is based on a $300,000 30-year fixed rate mortgage loan. As you can see, the mortgage loan interest rate is greatly affected by the quality of the FICO credit score and significantly impacts the size of the monthly mortgage payment.
|FICO Score||Mortgage APR||Monthly Mortgage Payment|
The good thing for borrowers with a poor credit record is that, while it's a primary factor in lenders' decision-making, other elements such as household income, work history, retirement savings, down-payment amounts and types of mortgage also factor into the decision -- and can even help overcome a blemished credit history.
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