We all know that a low credit score is bad news for a variety of reasons, but did you realize that it could also have a negative effect on how much interest you pay on a loan? In fact, your credit score is one of the most important elements a mortgage lender considers when developing your payment terms, including the interest rate you will pay.
Most credit scores fall somewhere between 300 and 850, and are used by lenders as a way to determine how trustworthy you are when applying for a home loan or line of credit. Since a high credit score will help you obtain a lower interest rate and a larger line of credit, it is a good idea to check your credit reports and ensure you are in good standing before applying for a mortgage or other loan.
Everything from paying your bills on time – which is known as your payment history – to the total amount of debt you currently owe is taken into account when the three major credit bureaus calculate your credit score. Generally speaking, payment history accounts for around 35 percent of your credit score, followed by the total amount of debt you owe at 30 percent, the length of your credit history at 15 percent, the amount of new credit you’ve obtained at 10 percent and the types of credit you’ve obtained at 10 percent.
In most cases, the higher your credit score is, the lower your mortgage interest rate will be. While your interest rate will obviously depend on the rates currently being offered, and you will need to speak with a mortgage lending professional to determine your actual rates, in general the percentage difference can be substantial. For example, someone with a credit score that falls between 760-850 could pay as little as 3.55 percent, while someone with a credit score that falls between 620-639 could pay as much as 5.139 percent. On a 30-year fixed rate mortgage loan of $100,000, this would amount to a difference of $33,663 in total interest paid!
Fortunately, you can significantly improve your credit score by taking a number of steps. First, be sure to pay all of your bills on time, including your energy bill, credit cards and rent, if applicable, because missed or late payments will definitely lower your credit score. Next, pay down (or off) any maxed out credit cards, and lower all of your existing credit card balances. Also, avoid opening new lines of credit for at least six months prior to applying for a loan.
Remember that your credit plays a huge role in determining if you will be eligible to become a homeowner, and also what interest rate you will be required to pay. Depending on your current credit score and circumstances, it might make sense to put off buying a home until your credit score has risen, as it could save you a substantial amount of interest in the long run.