Does my credit score really affect my interest rate?

(If so, how do I raise my score?)

Yes, your credit score is probably the single most important component to consider when making some of the biggest financial decisions of your life.  It is a huge factor in determining the rate you receive on your credit cards, your homeowner’s insurance premium, car loans and personal bank loans.  In this article, we will focus on the importance of your credit score as it pertains to your mortgage interest rate.  Other components such as your loan amount, percentage borrowed, type of loan, amortization schedule, and lock period are also contributing factors, but none are as important as your credit score.  Fannie Mae and Freddy Mac (the two entities that oversee 99% of all loans) are also BLACK AND WHITE when it comes to their credit score modules.  They place all borrowers into one of the following zones:

Scores below 620

Scores from 620 - 639

Scores from 640 - 659

Scores from 660 - 679

Scores from 680 - 699

Scores from 700 - 719

Scores from 720 - 739

Scores above 740

In Fannie Mae and Freddy Mac’s eyes, a borrower with a 660 score is exactly the same as a borrower with a 679 score; however, there is a HUGE difference between borrowers with a 699 score and one with a 700 score.  I know, it doesn’t seem fair, but those are the rules we must all live with.  The following examples of a 30-year conventional loan show how your credit score can affect your rate.

625 score – 5.125%

699 score – 4.875%

740 score – 4.50%

These are huge differences and can easily be the reason why you receive either an approval or denial on your loan application.  So, what makes up your credit score and how can you raise it up to another level?

There are three major credit reporting companies.  All lenders use the middle score from Experian, Equifax, and TransUnion to determine your mortgage score.  There are five major components that make up your credit score: payment history, debt amounts, length of credit history, new credit, and credit mix.  We will post future articles on the weight and importance of each of these factors, but for now, let’s concentrate on the one area that you can work on today to raise your score.

Revolving debt, more frequently referred to as credit card debt, is about the only area that you can change to immediately improve your credit score.  Most of the other areas take time.  Building a perfect mortgage history, paying down a large car loan, continuous payments on student loans, and putting years between you and a major default such as a bankruptcy or collection will certainly raise your score.  But, what if you don’t have the time or money to do these things?  Most people don’t realize that having a credit card balance near the maximum allowed credit is killing them.  In fact, many consumers will “max out” one card in order to pay down another.  This is not a good idea.  Here are two examples of the same amount of credit card debt that would have very different impacts on an individual’s credit score.

• Card One - $5000 maximum with a $4500 balance.  Card Two - $3000 maximum with a $2000 balance.  Card Three - $4000 maximum and a $0 balance.
• Card One - $5000 maximum with a $3000 balance. Card Two - $3000 maximum with a $1500 balance.  Card Three - $4000 maximum with a $2000 balance.

Scenario One has two cards nearly maxed out.  The first is at 90% capacity and the other is at 67%.  The third is at 0%.  This type of “balance” will kill your credit.  The bureaus view the high percentages as a caution that you are not able to control your spending and are likely to get in over your head.  These accounts will hurt you much more than the third account with the 0% balance will help you.

Scenario Two has the exact same amount of debt, but it is spread out to 60% of the maximum, 50% of the maximum, and 50% of the maximum.  Even with the 60% (which is really considered too high), the other cards at 50% are in great shape.  This person’s score would certainly be the higher of the two.   On-time payments with your long-term debts (such as your home mortgage and cars) will continue to raise your score.  For immediate help, however, you should consider paying your credit cards down to 50% or below their maximums!

For questions regarding your credit score or any other mortgage matters, please call Rotella Mortgage – 402-339-4426.