How Do Credit Scores Affect Home Loans?

A good credit score can make a lot of things more affordable. Not only will you likely get a lower credit card interest rate, but a positive credit check when you buy a car or apply for credit can lead to a better rate and much lower monthly payments.

This is especially true for home buyers with excellent credit scores, including married couples where one spouse has a poor or good credit score, and the other has an excellent credit score.

Leah Manderson, a financial planner in Atlanta, GA, bought a house with her husband last year and got a home mortgage loan that was half of a percentage point lower because her husband has an “excellent” credit score and she has a “good” score, Manderson says. His score got them a rate of 3.25%, while hers brought the interest rate up to 3.75%.

They were able to afford the house on just his financials, she says, and they saved $30,000 in interest over the life of the loan.

Fannie Mae loan criteria

Home loans from Fannie Mae and Freddie Mac have what are called Loan Level Price Adjustments, or LLPA, says Sean McGeehan, a mortgage loan officer in Illinios.

The chart for Fannie Mae loans, for example, lists pricing tiers based on credit scores. Depending on the loan-to-value ratio (LTV), an excellent credit score of 720 or more can add nothing to a home loan interest rate, while a credit score of 620 or less would adds 1.5% to the rate.

Loan-to-value is the ratio of a loan to the value of the property. For example, someone borrowing $130,000 to buy a home worth $150,000 has an LTV of 87%.

The loan rate can swing 1-2%, depending on the criteria and credit score, McGeehan says.

“If a home buyer is a 739, for example, we may coach them into paying down a credit card or we’ll look for inaccuracies on their credit report to help put them over the 740 mark for best case pricing,” says Sean McGeehan, a mortgage loan officer.[/pull_quote]”A 740 credit score or higher will typically put you in the best bucket of credit score pricing,” he says. “If a home buyer is a 739, for example, we may coach them into paying down a credit card or we’ll look for inaccuracies on their credit report to help put them over the 740 mark for best case pricing.”

LLPAs are considered in loans from the Federal Housing Administration, or FHA, McGeehan says. “This is one area when FHA sometimes becomes a better loan than conventional,” he says. “If you have someone with a 650 credit score and wants to do a low down payment program usually FHA’s rate will be better than conventional.”

600 credit score a ‘loan killer’

While a low credit score under 600 is a “loan killer,” even a score of 700 or better isn’t a slam dunk for a home loan at a great rate, says Gloria Shulman, owner of Centek Capital Group in Beverly Hills, Calif.

“Banks are equally as strict with income as they are with credit, and a strong W-2 will ideally position a borrower for the lowest available rate,” Shulman says.

How important is meeting both the credit and income requirements? The difference in the monthly payment for a $429,000 loan between the highest and lowest scores is easily more than $300, which over a 30-year fixed mortgage can add up to more than $100,000, she says.

Interest rates can vary as much as 1.5% for credit scores between 650 and 700, she says.

740 is the new 680

Lenders give better interest rates to people with high credit scores because they’re more likely to make payments on time.

But having a score over 740 doesn’t mean you’ll get a lower interest rate than advertised, says Gregory Meyer, community relations manager at Meriwest Credit Union in San Jose, Calif. “It just means you are more likely to be granted a loan with the advertised lowest rate,” Meyer says.

“As our scores go lower than 740, we may see some increases in interest rates for home loans. Some mortgage companies are still able to make loans at good interest rartes to people with scores as low as 680,” says Gregory Meyer of Meriwest Credit Union.[/pull_quote]”But as our scores go lower than 740, we may see some increases in interest rates for home loans,” he says. “Some mortgage companies are still able to make loans at good interest rates to people with scores as low as 680.”

A 680 was the best credit score to shoot for before the Recession, but since then, increased loan defaults have caused lenders to raise the bar for credit scores to 740 and above.

“When a borrower is below the 700-680 range, it becomes more difficult to qualify for a good interest rate,” Meyer says.

That can lead to “risk based pricing” where a borrower with poor credit is charged a higher rate to offset the risk in lending to someone with less than perfect credit, he says.

“During the Recession, this practice was frowned upon by regulators and was not in regular use,” Meyer says. “We are starting to see more of this sort of lending as the economy slowly improves.”

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