What determines my mortgage rate?
There are many factors that will determine what mortgage rate you will qualify for:
- Loan to value (LTV) – determined by your down payment or equity in your home
- Debt to income ratios (DTI) – determined by your adjusted gross monthly income vs. your monthly debt expenses
- Transaction type – purchase/refinance/cash-out refinance
- The biggest factor: your credit score.
Your credit score, specifically your FICO score, has the single biggest impact on the rate you will qualify for, especially when looking at conforming and jumbo loans (FHA and VA loans are more flexible when it comes to credit).
You have three FICO scores, one from each credit bureau, Experian, Trans Union, and Equifax. All of the bureaus have slightly different calculations on what they look at when determining your score. In addition, the calculations are adjusted depending on what type of debt you are applying for. Your FICO score when applying for a credit card or car loan will be different than when applying for a mortgage.
What determines my credit score?
While the credit bureaus don’t publish how they calculate a credit score, below is how some experts think a FICO score is weighted.
1. Payment history on things like credit cards, car loans, mortgages, etc. (~35%)
2. Balances vs. available credit on revolving debt like credit cards or personal loans (~30%)
3. Length of time you’ve had established credit (~15%)
4. Recent credit inquiries (Multiple credit inquiries within a short time-frame when applying for a mortgage will not have a significant impact on your score (~10%)
5. Type of credit (Ideal combination is a mortgage, a car loan and two to three active credit cards (~10%)
So what impact does a credit score have? In the chart below I provide the impact your credit score has on the closing costs for different credit score ranges.
Rates below were verified on 1/22/2016
30 Year Fixed $500k Purchase, 20% Down, Primary SFR
|Rate||Disc/Net Orig||APR||P&I Payment||Total Closing Costs||FICO|
|3.750%||0.000%||3.786%||$1,852||$3,278||740 – 850|
How do I improve my credit score?
If you are not currently considering refinancing or purchasing a new home, it is wise to check your credit report to ensure nothing is being reported inaccurately. Credit reporting errors are more common than they should be and can be very difficult to correct in a short period of time. If you are proactive, you can save yourself from a big surprise once you are ready to apply. Free credit report sites are an easy and free way to check against errors on your report; however, don’t expect to find out your credit score without paying a fee.
If you are currently in the market for a new home or considering financing, having your credit checked as part of your application is the best way to go. This will let you know exactly where you currently stand and whether or not work has to be done to improve your score. If you choose the right lender and work with an experienced professional, they should be able to advise you whether there is anything that can be done to improve your situation. I would not recommend trying to pay down debt or close down credit ahead of time without consulting with a loan professional first. Often we see clients try to improve their situation only to make things worse and jeopardize their loan approval.
Aside from removing late payments from your credit report, which can be difficult if they are being reported legitimately, the easiest way to improve your credit is to pay down the balances on your revolving debt. For example, if you owe $1,000 on a credit card and the maximum balance on the card is $1,000, your credit will suffer as a result; however, if you can pay down the balance below 75%, 50% or ideally 25% of the credit limit, your score may see a nice bump higher. Again, I would caution doing this on your own prior to speaking with a mortgage professional, as there are times when paying down debt can backfire if those funds were needed to qualify for a mortgage.
The last resort to improve your score would be to use a credit repair company. If you decide to go this route, check with your lender to see if they have anyone they would recommend. Additionally, make sure you avoid any credit repair company that charges a large upfront fee for their services. Most reputable companies will offer a free consultation and charge on a monthly basis with no long term contract.
Have questions? Sammamish Mortgage is a local, family-owned company based in Bellevue, Washington. We currently lend in all of Washington, Oregon, Idaho and Colorado. Please contact us if you have mortgage-related questions.