Mortgage Rates and Credit Scores
While on the one hand you don’t want to be swept up in credit score mania, you also might find helpful to know just how much money you can save on a loan with a high score. Then you’ll be motivated to get your act together and boost your score, which you can do!
The Mortgage Rate – Credit Score Connection
Directly from FICO®, the master of the credit score universe, take a look at the relationship between credit scores and mortgage rates. (The images below are screenshots, so not clickable. You can find the live gizmo on the myFICO website if you want to play around with it.)
First, I’ve done an example for a $150,000, 30-year mortgage loan with the current (as of 24 April 2015) national average mortgage rate.
Look at the huge difference in the APR for the highest and lowest credit score ranges. If your score were in the top tier, your APR would be 3.348%. But if you’re in the bottom tier, you are stuck with a 4.937% APR!
Now let’s take a look at a 15-year mortgage:
A stellar credit score earns you a very low 2.660% APR, while those with blemished credit reports get an APR of 4.249%. Again, a rather mammoth difference.
What’s This Mean in Dollars and Cents?
The rate differences are big, but the important pocketbook questions are:
- what’s the difference in the monthly mortgage payment between the top and bottom credit score tiers, and
- what is the total interest cost difference over the mortgage’s life?
The monthly payments are shown in the images above. I’ve repeated them here, added the total interest costs for the life of the mortgage, and did the difference calculations. Here are the results:
The impact of the high credit score is stunning, don’t you think? Just by optimizing your credit score before you take on a mortgage, you would save $49,882 in interest cost over the life of a 30-year mortgage and $21,028 on a 15-year mortgage. Wow!
Optimize Your Credit Score Before You Apply for a Mortgage
The message here is clear: optimize your credit score before you take on a mortgage. Start now, because improving your credit rating takes time, regardless of what you’ve been told by “credit repair” scammers. (Read “Credit Repair: Always a Rip-Off” for more on that topic.)
If you’re hazy, the Money Counselor Simple Guide “Raise Your Credit Score the Right Way” includes everything you need to know to optimize your credit score. As you’ll learn in the Guide, the benefits of a high credit score are many, even if you don’t borrow money. For example, low credit score mortgage applicants would probably also pay a higher insurance premium for the same house—and for their car insurance!
This is slightly off topic, but I must also comment on the massive interest cost difference between a 30-year and 15-year mortgage: about $55,000 less interest cost for the high score borrower and $86,000 for the low score borrower between 30-year and 15-year terms. If you are not comfortable committing to the higher payment that goes along with a 15-year mortgage, check out my recommendation for saving nearly as much interest while still signing with the lender for a 30-year mortgage.