Borrowing

This credit score can save you thousands of dollars when buying a home

Twenty/20

If you're thinking about buying a home, it's important to start monitoring your credit score. 

The higher your credit score, the lower the mortgage rate you're eligible for, so you'll want to take steps to maintain or boost this key three-digit number. Having a great credit score rather than one that's just OK can save homebuyers tens of thousands of dollars over the life of a mortgage. 

Ideally, you'll need a credit score of at least 760 to qualify for the best rate on  conventional 30-year mortgage. If your score is below that, getting it mortgage-worthy can take some time and effort. Here's what you need to know.

Understand what goes into your credit score

There are lots of different kinds of credit scores, but most lenders use FICO's scoring model, which ranges from 300 to 850. A "good" FICO score is anything above 700, and scores over 760 are considered "excellent." The average national credit score is 706, according to FICO.

Your credit score tells lenders how likely you are to pay back money you've borrowed. It provides lenders with a snapshot of your creditworthiness and reflects "how you've done paying back people who have loaned you money in the past," says Tendayi Kapfidze, chief economist at LendingTree.

Your credit score is based on data in your credit report, which details information like how much debt you carry and whether or not you've made your payments on time.

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Before you start looking for a house, familiarize yourself with your credit, first by checking your credit report. You can access your reports from each of the three major credit reporting companies — Equifax, Experian, and TransUnion — for free at AnnualCreditReport.com. Look for any errors that could put a dent in your score. 

Taking this step can be well worth the effort. Some 20% of consumers who spotted and corrected an error on their report saw their credit score improve as a result, according to a 2015 report from the Federal Trade Commission

Then check your current credit score. Your bank or credit card issuers may give customers access to a free credit score on their monthly statements or in their account online. If your bank doesn't offer this service, check out a third-party site like Bankrate.com, CreditKarma.com, and Credit.com for a free credit score. 

Each third-party site may give you a slightly different number due to differences in scoring brands and which data they pull. Though these numbers aren't exactly what the bank sees, they'll give you a general idea and some details about what factors are helping or hurting your number.

Once you know your current credit score, you're poised to raise it. 

A score of at least 760 can get you the best mortgage rate 

When you apply for most consumer loans, like a new line of credit or an auto loan, lenders pull a credit report from one of the three major credit reporting bureaus and base their decision off of that one report.  

But "with mortgage lending, it's entirely different," says John Ulzheimer, a credit expert who has worked for FICO and Experian. When you apply for a mortgage, the mortgage lender or broker is going to pull all three of your credit reports and the score associated with each, he says.  

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If you're applying with your spouse or partner, that means the mortgage lender is looking at scores and reports for both of you, and they're "going to take the middle numeric score for the basis for their decision," says Ulzheimer. "It's a safe, middle of the road approach." 

To get a great rate on a mortgage, it helps to have that middle of the road score be 760 or higher, explains Ulzheimer. That's the score you'll need to qualify for the best rate on a "garden variety, 30-year conventional fixed mortgage."

Typically, you can qualify for a conventional mortgage with a FICO score as low as 620, says Ulzheimer. Though the coronavirus pandemic has prompted some lenders to tighten restrictions on which prospective homebuyers qualify for loans, "there are still rates being quoted for scores as low as 620 so it seems like there are still options, albeit probably more expensive options," he adds. 

Recognize that if you qualify for a loan with a subprime credit score, you'll likely end up paying more at the outset: "It's going to be some special program where you may need to pay more to offset the amount, or put more money down," says Ulzheimer.  

You'll also pay more over time. With a subprime score, your interest rate will be higher than a homebuyer with a great score, and you could end up paying tens of thousands of dollars more over the life of the loan. 

How much money you can save with a better score

Say your credit score is around 620 and you're planning to take out a mortgage for $320,000, which is the median U.S. home price as of March 2020. With that score, your current mortgage interest rate would be around 4.62% for a 30-year fixed rate mortgage. Your monthly payment would be $1,646, and you'd pay $272,427 in interest over the life of the loan, according to FICO's loan savings calculator.

Now say you had a score of 760. You'd be able to snag the best interest rate of 3.03%, lowering your monthly payments to $1,356 and the overall interest you'd pay to $168,052. That means with a 140 point increase in your credit score, you'd see a  significant savings of $104,375 in interest over the life of a loan. 

'The biggest thing' to help boost your credit

Prospective homebuyers can improve their credit scores, especially if they start well before they begin house-hunting, says Kapfidze. "Certainly, when you first get the idea that 'Hey, I want to buy a house,' you definitely want to start working on your credit score at that moment," he says. 

Your goal in improving your score is "to go from a higher-risk to a lower-risk borrower," adds Kapfidze, and if you do, you'll likely qualify for more favorable loan terms. 

Certainly, when you first get the idea that 'Hey, I want to buy a house,' you definitely want to start working on your credit score at that moment.
Tendayi Kapfidze
Chief economist at LendingTree

Here are three things you can do to boost your credit score before applying for a mortgage:

  1. Set up automatic bill payments. If you can make one change to help your credit score, "the biggest thing" is to "never be late" on your monthly debt payments like student loans or credit cards, says Kapfidze. Stay on top of those payments by setting up autopay.
  2. Create a debt repayment plan. Ted Rossman, industry analyst at Bankrate, recently told Grow that "the most impactful thing that consumers can do to quickly improve their credit score is to lower their credit utilization ratio." Your utilization rate is the ratio between how much you owe on a credit card compared to the available credit. You want to keep it as low as possible, ideally below 30%, and you can do so by limiting your new charges, avoiding closing old cards, and creating a plan that helps you pay down debt rather than add to it.
  3. Limit new credit requests. Every time you have a lender assess your creditworthiness, there's a temporary ding to your credit score. So in the months leading up to shopping for a mortgage, try to avoid making new credit requests, whether that's applying for a credit card, financing a new computer, or refinancing your student loans. 

"What happens pretty commonly these days is the lender may pull your reports a day or two before closing," explains Ulzheimer. Play your cards right, and that last-minute check will reflect the hard work you've put into improving and maintaining your score — helping you get the best possible rate.

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