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Anyone exploring home ownership probably knows that rising interest rates and rising home prices make that goal a challenge.
The average rate on a typical 30-year fixed-rate mortgage has zigzagged between 6% and 7% in recent months — down from above 7% in early November but roughly doubling the average rate of 3.3% into 2022, according to for Mortgage News Daily.
But the interest rate that certain buyers can qualify for depends at least in part on their credit score — meaning you have control over whether you can get the best rate, experts say. And the difference between a good or excellent score in terms of monthly payments — and the total interest you pay while you hold the mortgage — can be significant.
“The score affects everything: the loan approval, the interest rate, the monthly mortgage insurance premium … and the final payment,” said Al Bingham, credit expert and mortgage loan officer with Momentum Loans.
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The median home price in January was $383,000, according to Redfin. Although prices have been declining since mid-2022, the number is still 1.5% higher than a year earlier. In January 2020, the median was less than $300,000.
While you can negotiate on the price of the house to reduce the overall cost of home ownership, it is also worth making sure that you go into the process with as high a credit score as possible.
Lenders check three scores but use one number
Although things like steady income, length of employment, stable housing and other financial aspects are important to lenders, your credit score provides additional information.
The three-digit number – which ranges from 300 to 850 – feeds into the lender’s calculation of how risky it is to borrow you. For example, if you always pay your debts on time and you have low credit utilization (how much you owe relative to available credit), your score will benefit.
And the higher the amount, the less risk you are to the lender – so the better terms you can get a loan.
Lenders review home buyers’ credit reports and assign scores to each of the three major credit reporting companies: Equifax, Experience and TransUnion. For mortgages, the scores provided by these companies are usually specially developed by FICO, as these scores are now relied upon by Fannie Mae and Freddie Mac, the largest purchasers of mortgages in the secondary market. (In the years to come, this reliance on one score will change.)
However, because a specific FICO score can vary among the three credit reporting companies because of differences in what is reported and over time, mortgage lenders use the middle number to inform their decision.
The higher your score, the lower the interest rate you will be charged. Just to illustrate: On a $300,000, 30-year fixed-rate mortgage, the average rate is 6.41% (as of Thursday) if your credit score is in the 760 to 850 range, according to FICO.
This would make the monthly principal and interest payments $1,878. On top of this amount are usually property taxes, homeowner’s insurance and, if the down payment is less than 20% of the sale price of the home, private mortgage insurance.
In contrast, if your score falls between 620 and 639, the average rate available is 7.99%. This means a payment of $2,201 (again, just for principal and interest).
Most monthly payments accrue interest at first
Because of how the loan is structured, most of the monthly payments will go toward interest at the beginning of the loan rather than toward principal.
For example, if you start paying a $300,000 mortgage next month at a rate of 6.41%, in two years you’ll pay $39,600 in interest and only $7,438 in principal, according to Bankrate’s mortgage calculator.
By comparison, a 7.99% rate means that in two years, you’ll pay $49,570 in interest and $5,455 in principal, according to Bankrate’s calculator.
There are ways to improve your credit score
If you want to get a score before applying for a mortgage, there are a few important things you can do.
“Improving your credit score is really the bottom line,” says Ted Rossman, senior industry analyst for Bankrate. “You must aim to pay your bills on time, so that you have less debt and show that you can manage various types of credit over time.”
And, he said, there are some things you can do to improve your score quite quickly.
“My favorite is to lower your credit utilization ratio,” says Rossman, referring to credit card balances. “It resets every month and usually reflects your statement balance, so you can have a high utilization ratio even if you pay off your credit card in full to avoid interest.”
You may want to consider making an extra mid-month payment or asking for a higher credit limit to bring the ratio down, he said.
“That is often recommended to stay [the ratio] below 30%, even below 10% is even better, and your credit score should improve as long as you’re down,” says Rossman.
He also recommends checking your credit report — which you can do for free at annualcreditreport.com — before applying for a mortgage. “Find mistakes and correct them as soon as possible,” he said.