How does having a better credit score affect your mortgage rate, and how much could it lower your monthly payments? Let’s do some interesting mortgage math to find out!
I know what you’re thinking: “There’s no such thing as interesting math.” But stick with me. The following numbers will show you how a better credit score could lower your monthly mortgage payments by hundreds of dollars. Ah, now I have your attention!
You probably already know that earning a higher credit score will help you obtain a lower interest rate on your mortgage loan. This is a result of risk-based pricing. When lenders view borrowers as a higher risk, they charge more interest. Low-risk borrowers, on the other hand, are generally charged less interest. And credit scores were specifically designed to be risk indicators.
Granted, the lender will also consider your income, your overall debt, and other factors. But your credit score is one of the leading factors that can affect your mortgage rate. It can also determine whether or not you get approved for a loan in the first place. So the better your score, the better your chances of getting a mortgage with a good interest rate attached to it. That’s one of your primary goals, as a borrower.
But how does all of this translate into monthly savings? Let’s do some basic math to find out. Here’s a realistic scenario that shows how a higher credit score can affect the borrower’s mortgage rate and monthly payments.
Example: How Credit Scores Affect Mortgage Rates, Payments
Let’s say I’m shopping for a home loan in the amount of $250,000. So I find a mortgage lender and apply for a loan. During the application process, I find out that my credit score is 600, which is at the bottom of the lender’s qualification scale (pretty realistic for 2014, by the way). I’m able to get approved with a score in this range, which is good. But I won’t get the lender’s best interest rates at this level — not even close. I would need a much higher score for that.
So here’s how the numbers work out. I’ve taken home insurance and other non-mortgage costs out of the equation, for the sake of simplicity.
Mortgage Scenario #1
- I opt for a 30-year fixed mortgage.
- The loan amount is $250,000.
- My FICO credit score is 600.
- The lender approves me for an interest rate of 5.4%.
- My mortgage payment comes out to around $1,403 per month.
Now let’s assume I went through this same process with a better credit score, and with all other factors being the same. How does this affect my mortgage rate and monthly payments? How much money do I save? Here are the numbers:
Mortgage Scenario #2
- Once again, I choose a 30-year fixed mortgage.
- The loan amount is the same — $250,000.
- This time, I have a better credit score– 780.
- The lender approves me for their best rate, which is 4.15%.
- My mortgage payment comes out to around $1,215 per month.
In this scenario, I could save nearly $200 per month, just by having a higher score and securing a lower rate. What does that savings amount mean to you? Half of a car payment? A few trips to the grocery store? More money to put toward savings, or perhaps a few more dinners out each month? However you spend it, we can both agree that it’s better to put that money into your own pocket than the lender’s pocket.
This is a realistic scenario, by the way. I didn’t pull these numbers out of thin air. I used Freddie Mac’s weekly mortgage survey to get the current average mortgage rates (at the time of publication), and I used an accurate mortgage calculator provided by Bankrate.com to determine the monthly payments. The results show how your credit score affects your mortgage rate and, by extension, your monthly loan payments.
The bottom line is that you can save a lot of money by improving your credit situation before buying a home.
If you find out that your score is low, and you want some tips for improving it, you’ll find plenty of advice here on our website. I recommend starting with this tutorial. You can also find a lot of good information on the MyFICO.com website (it’s owned by the company that actually designed the FICO credit-scoring model, used by most mortgage lenders).
Disclaimer: This article explains how credit scores can affect mortgage rates and the resulting monthly payments. Lender’s use a variety of factors when assigning interest rates to home loans. They consider the “whole borrower,” instead of looking at just one factor. The examples provided above are generic in nature and may not apply to your situation. This article has been provided for educational use and does not constitute financial advice. Please do not make any financial decisions based solely on the information presented above.