What You Need to Know About Mortgages and Your Credit Scores
If you’re like most Americans, the largest purchase you will make in your lifetime is a house. Due to its outsized financial impact most home buyers finance their homes and pay it off over the course of three decades (although 15 year mortgages and other options are available as well). That’s why it may be unfortunate for some that the amount they pay in interest on their home loan will be based on what their credit scores are today and not where they might be in 30 years. This can make a huge difference, e.g. someone with a lower qualifying credit score could pay as much as 3% more than a person with a score of good to excellent.
Further complicating things, as Nick Clements at Forbes recently detailed, many banks and mortgage companies actually use different credit score metrics when approving mortgage applications than other creditors use. This means that the credit score you’ve viewed for free on sites like Credit Karma or even paid for using other services might not be the exact same one that a lender will see when you apply for a mortgage. So how do these mortgage lenders decide which credit scores they use and how do they determine your overall creditworthiness?
The many versions of FICO
Although FICO — the leading model for calculating credit scores in the U.S. — is now employing their ninth version, mortgage lenders tend to use much older versions. Furthermore each of the three credit bureaus uses a different one for mortgages, with some going as far back as version two. As a result it may be difficult to know what score(s) a lender will see.
The good news is that, while some versions do include some tweaks, the basic FICO model remains the same. Likewise the score you see is likely to be in at least the same range as the one mortgage lenders will calculate. That is to say, if you have solid Good credit rating, these quirks are unlikely to affect your rate. The issues arise when your credit score is on the borderline, e.g. the difference Fair and Good or Good and Excellent. Jumping up to the higher rating can have a significant impact on the interest rate you will be paying for the next 30 years. In those cases taking a closer look at your credit reports and putting off your mortgage application in order to make adjustments, e.g. paying off credit card balances in full, could be worth it for your financial future.
Different credit scores from different bureaus
As mentioned each of the three credit bureaus calculates their own credit score for you based on what they have in your credit report. These scores can actually vary pretty greatly from one another since some creditors will only report to one bureau and not the others. This allows for the possibility that one score will show major issues while the others are spotless. So which will lenders look at? It depends.
In most cases lenders will access at least two of your credit scores. From there they’ll take the lower of two scores in making their decision. Alternatively, if they obtain all three scores, they’ll use the middle number. Since you likely won’t know which bureaus scores they’ll be pulling, just assume that they’ll be using the lowest of your scores and keep that in mind when evaluating if you’re in good shape or not.
While FICO credit scores are undoubtedly the biggest factor in determining your creditworthiness, it may not be the only one. Along with your score comes an entire credit report that lenders can pull any number of data points from. For example Fannie Mae will now be taking a closer look at how applicants use their credit cards when it comes to determining their interest rate. This is because those who carry a balance on their credit cards (even if it’s a low utilization rate) are regarded as riskier borrowers than those who pay off their cards each month. Meanwhile other lenders might have their own preferred trends to look at, which could either help or hurt your application’s prospects and/or your rate.
Whether it’s your first home or your fifth, applying for a mortgage is always a big deal. With an interest rate that will likely follow you for up to 30 years, there’s good reason why applicants may be curious about what their credit scores will tell lenders about them. If your credit scores are on the border of being good, your scores vary significantly between bureaus, or you have other personal finance issues (such as paying off your credit card balance monthly) to master first, it may be best to hold off on buying a home until your credit is in the best shape it can be. While it may be a pain to wait now, it will likely save you a substantial amount of money in the long run.