Housing prices have soared throughout the pandemic, but that hasn't stopped people from buying. Low supply and low interest rates have driven demand, leading to bidding wars and making this a challenging time to buy a home.
Despite those hurdles, buying now can still pay off. Mortgage rates have been trending higher recently, but are still near record lows, saving you money in the long run. Plus, homeownership can still be a reliable way to build wealth, according to experts.
If you want to buy a house but are worried about being able to afford one, don't forget about an important tool that will help you get that dream home: a high credit score.
"If you really are interested in buying yourself a home, getting your credit rating as high as it can possibly be really does come into play," says Keith Gumbinger, vice president at mortgage research site HSH.com.
Although you can typically qualify for a mortgage with a credit score as low as 620, raising your score even higher can allow you to save on interest and qualify for a larger mortgage. Credit scores help lenders gauge your trustworthiness for paying back a loan, and the higher your score is, the more likely you are to qualify for a lower rate.
Here is how having a higher credit score can help you qualify for a larger mortgage or lower your monthly payment.
When you apply for a mortgage, lenders look at what your required monthly payments will be and how they fit into your budget. They typically follow the 28/36 rule, which stipulates that no more than 28% of your pretax income goes toward housing expenses and no more than 36% goes toward monthly debt.
This is where your credit score comes into play.
"For the most part, a higher credit score means a lower mortgage rate, a lower rate means a lower monthly payment, and a lower monthly payment means your income can support a larger mortgage," says Gumbinger.
Let's consider a potential homebuyer with an annual income of $80,000, $20,000 saved for a down payment, monthly debt obligations of $300, and an excellent credit score of 760. According to FICO, this homebuyer could qualify for a rate of 2.744% on a 30-year fixed loan. Based on those parameters, among others, HSH estimates that homebuyer could afford a $319,000 mortgage.
For another homebuyer with the same income, down payment, and debts, but a credit score of 680, the rate goes up to 3.143%. Because more of their monthly payment is going toward interest, that reduces the potential mortgage amount to $308,000, a difference of $11,000.
Just as important, a lower monthly payment can free up funds for other financial goals. For a $300,000, 30-year mortgage, the homebuyer with a 760 credit score could pay $1,224 per month, FICO estimates, while the one with the 680 score could pay $1,288. The difference of $62 per month may seem small, but it adds up to more than $23,000 over the life of the loan.
You can use Grow's mortgage calculator to see how interest rates affect the monthly and total cost of a home loan.
If you're looking to buy a home soon but don't have a top-notch credit score yet, here are three things you can do to boost your rating:
- Commit to paying down your balances: Getting your student loan, credit card, and car loan balances as low as they can be will lower your utilization rate, which makes up 30% of your credit score. The optimal rate is less than 30% of your available credit. In addition to boosting your score, lowering your balances will allow you to put more of your income toward your down payment and can help you qualify for a bigger mortgage, according to Gumbinger.
- Pay on time: Payment history makes up 35% of your credit score, so paying your bills on time each month goes a long way toward improving your rating. If you can pay more than the minimum or even in full, so much the better. "Paying down your balance is the best thing any cardholder can do to move their credit score from 'good' to 'great,'" Matt Schulz, chief credit analyst at LendingTree, told Grow last year.
- Consider a balance transfer credit card: Balance transfer cards allow you to move an outstanding balance from an account with a high interest rate to one with a lower rate. Transferring a balance can save you money in interest. Opening a new line of credit can help lower your utilization rate, too, but is likely to trigger a short-term drop in your score. If you're just a few months away from trying to buy a home, this might not be the best strategy. "Proceed with caution," Schulz told Grow.
Though it helps to boost your score, there is a limit to how much you can benefit. Although credit scores go up to 850, there is usually no improvement in rate once you reach a score of 760. For loans that conform to the requirements of Fannie Mae and Freddie Mac, which make up about 80% of all mortgages according to Gumbinger, 740 is the score you need to qualify for the best rate.
If you're not sure where your score falls, you can often access your credit score for free from your bank or credit card issuer, or from a third-party service. Mortgage lenders will check in with all three credit bureaus — Equifax, Experian, and TransUnion — so it's a good idea to check scores from several sources to get a sense of where you land.
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