Understanding the Role of Credit in the Homebuying Process
As Georgetown TX home buyers work toward getting a mortgage, their creditworthiness will come up many times throughout the process. By analyzing credit scores and their underlying factors, lenders can assess risk and determine if the homebuyers qualify for the mortgage loan. The credit scores also come into play as lenders calculate the terms of the loan for qualified homebuyers. Understanding the role of credit in the homebuying process can help everyone navigate this process with much less stress and frustration. Here's what everyone needs to know.
What Lenders Look for in Credit Scores
As mortgage lenders assess each applicant's risk of default, they look at the credit score and all its most influential factors. With a glance at the credit score, lenders can tell if the applicant might qualify for the loan. In general, most lenders cannot authorize mortgage loans for anyone with a credit score less than 640. A credit score of around 700, however, not only improves eligibility but also helps homebuyers attain favorable loan terms.
Factors That Influence Creditworthiness
Weighing credit worthiness goes far beyond simply looking at the credit scores. Lenders also look at the factors that shape these scores to see who the applicants manage their finances. They look at the payment history first as this factor can reveal if the homebuyers will make their mortgage payments on time. Lenders can see all the most recent 30, 60 and 90 day late notices attached to open and closed accounts. The late payment history decreases the chance of qualifying for the mortgage and drops credit scores quite a bit.
Credit utilization and age of accounts are also both important factors for lenders to consider. By looking at credit utilization, lenders can assess the level of debt held by the applicants along with their ability to cover all their financial obligations. The age of the accounts give lenders a glimpse at the financial responsibility and standing of the applicants over a specific length of time. Older accounts that remain in good standing have a positive impact on credit scores and the perceived creditworthiness of home loan applicants.
Although this factor has a minor pull on credit scores, lenders check for a high number of credit inquiries while processing the mortgage loan application. These inquiries stay on the credit report for two years before dropping off. When applicants have a high number of inquiries, lenders tend to see it as a red flag – and credit scores start to drop from the excessive inquiries.
Ways Credit Can Impact Home Loan Terms
Beyond their use as a tool for determining eligibility, credit scores have a big impact on the final loan terms offered to the homebuyers. Here are just some of the ways these the scores influence mortgage terms.
Mortgage Interest Rates
As a part of their risk-based pricing model, mortgage lenders use the applicant's credit score to determine the mortgage interest rate for their loan. A low credit score often causes the interest rate to skyrocket, resulting in higher monthly payments and loan payoff costs. People with a high credit score of at least 700 might quality for a home loan with a 3.6% interest rate, for example, while those with a 625 score might get assigned a higher rate of 4.1%. Therefore, it is possible for homebuyers to save their households a lot of money by increasing their credit score before seeking a home loan.
Loan-to-Value Ratio Allowances
Lenders use different loan-to-value (LTV) ratios for people with high and low credit scores. This ratio reflects the overall value of the home compared to the total amount of the loan. The loan programs offered by the lender may use the credit score of the applicant to determine their ideal LTV ratio. For conventional mortgages, the LTV usually cannot fall below 80%, but for some programs, a high credit score may make up for that discrepancy.
Yearly Private Mortgage Insurance Costs
When homebuyers do not have a 20% down payment, they may have to take out private mortgage insurance (PMI) to qualify for the mortgage loan. Their credit scores also have an impact on the cost of this type of insurance. The private mortgage insurance companies take a look at the applicant's credit score to determine their personalized rate. Those with a credit score of more than 750 will only pay a half percent of the home's purchase price in PMI costs each year. For applicants with a 680 and below credit score, they can expect to pay twice that rate.
Improving Your Credit Prior to a Mortgage Application
Most mortgage lenders expect home buyers to have good credit when they apply for a mortgage. Buyers who do not have good credit may still be approved for a mortgage, but often lenders will charge higher interest rates and may require a larger down payment. Finding a lender with bad credit can also take longer. Improving credit prior to the mortgage application can make borrowing easier. Buyers can do the following to improve their credit:
- Pay bills on time.
- Pay more than the minimum balance on credit cards.
- Do not accumulate too much debt.
- Do not apply for loans that require a credit tug before applying for a mortgage.
- Do not close unused accounts.
Improving credit can take time, so home buyers who want to be approved for a mortgage may need to defer their home buying plans until their score improves.
As lenders weigh all the different creditworthiness factors for their home loan applicants, they are able to determine eligibility and set the right terms. This allows the lender and homebuyer to work together to find a mutually-acceptable financial agreement. Through this arrangement, the lender can assume a comfortable level of risk while allowing homebuyers to pursue their dreams of homeownership.