Want to secure rock-bottom interest rates? Your credit score matters.
How knowing and improving your credit score can save you tens of thousands of dollars
I’m sure you hear it all the time, “Interest rates are rock bottom! Now is the time to buy!” And by many accounts, that’s true. Even though interest rates have inched up a bit, they’re still at record lows. For those looking to purchase a home, now may be a great time indeed.
The problem is you can’t just march in to a bank and expect them to lend you money at these rock bottom rates. Since the housing bubble burst a few years back, lending requirements are stricter than ever. Banks now require prospective borrowers to go through a terribly burdensome application process. One of the key factors banks analyze is a person’s credit score. Your credit score provides the bank with an assessment of your financial stability and your ability to repay the mortgage consistently and on time. The higher your credit score, the lower the rate the bank will offer you.
This matters for you as a homebuyer because, even though interest rates are low, if you have a bad credit score you won’t be able to lock a mortgage at these low rates. And importantly, the lower your interest rate, the less money you’ll spend each month.
Let’s look at the chart below. Using the myFICO Loan Savings Calculator, it’s easy to see how interests rates vary based on credit score.
The above example is using national rate averages as of 7/27/17. If two otherwise qualified candidates approached a bank looking to take out a $200,000 mortgage, one with a 760 credit score and another with a 639 credit score, the difference in payments on the exact same loan amount could be a staggering $188 each month! The additional $188 isn’t helping you build equity—it’s being thrown away to cover the cost of the higher interest rates. Just think of all the ways you could use that additional money each month—home improvements, paying off student loans, saving for retirement, or saving for a family vacation!
Before shopping around for a mortgage, run your credit report with all three credit bureaus. Credit scores range from 300 (poor) to 850 (excellent). Banks usually require a minimum credit score of 620 to qualify a person for a mortgage. As noted above, ten points in one direction or another can dramatically affect the amount of interest you’ll pay over the lifetime of your loan.
What do the credit bureaus evaluate? They look at a number of factors, including income to debt ratio, recent credit inquiries and credit utilization.
Once you run your credit report, be sure to look it over with a fine tooth comb in case there are any discrepancies. According to the Federal Trade Commission, at least 20% of Americans have one or more significant error on their credit reports. With recent security breaches, it’s more important than ever to ensure your credit history accuracy. If you find mistakes, file a claim with the credit bureau website. Get the claim process going right away, as it can take up to 60 days to resolve—which may impact your ability to lock in favorable loan terms if you’re looking to buy a house in the near future.
If you find yourself with a low credit score, don’t panic. There are a number of ways to improve your credit score:
- Keep credit card balances low and pay bills on time. Delinquent payments and/or collection proceedings can destroy a person’s credit score. One way to keep your credit card balances low is to pay more than the minimum monthly payment in order to chip away at the principal balance without your monthly payments being swallowed to cover interest.
- Avoid the temptation to close credit lines. It may sound counterintuitive (“Why would I keep a line of credit open if I’m not using it?”), but having lines of credit available with no balance will improve your credit score. One of the factors in determining your credit score is credit utilization, or how much credit you have available to you that remains untapped. THAT SAID, don’t open new credit cards for the sake of increasing your credit capacity. Banks do not like to see more than two new accounts opened each year.
- Only initiate new loans if absolutely needed. That new car may seem like a great deal, but the combination of new credit inquires and additional debt will only hurt your credit sore.
If you’re still unsure how various decisions will affect your credit, use a credit score simulator (try this one from Credit Karma) to play with different scenarios—like paying off a credit card in its entirety, or increasing a credit card’s limit.
Importantly, start early! It can take months, if not years, to improve your credit score or resolve credit delinquencies. If you’re planning to buy a home within the next year, now is the time to get your credit in check so that when you’re ready to approach the bank, you’ll be guaranteed to lock in the lowest rates. It’s a small investment on your part now and will prove wildly beneficial in the long-run.