Moving From Fair To Very Good Credit Could Save You $54,000 Over The Lifetime Of Your Mortgage

Your credit score is one of the most important numbers in your financial life. It goes a long way toward determining whether you’re approved for loans, along with the interest rates you’re charged.

That impact is most significant for mortgages given that it costs a lot of money to buy a home and the loan stretches on for a long time (30 years, in most cases). The thing is, you can’t snap your fingers and improve your credit score when you suddenly decide you want to buy a home. You know all those months or even years you’ve been saving for your down payment? During that time, you should already be thinking about your credit score and how it can help — or hurt — you when it comes time to make that home purchase. 

In other words, don’t focus so much on whether you can afford a home that you forget to focus on setting yourself up for mortgage success along the way.

@bankrate

Your credit score isn’t just a number—it’s what lenders use to price your future. A stronger score can mean lower rates, better terms and more options when it matters most. Here’s how to start improving it today.

♬ original sound  – Bankrate

Have a question about credit scores? E-mail me at ted.rossman@bankrate.com and I’d be happy to help.

Running the numbers

“OK, but homes are expensive no matter your credit score. It can’t matter that much if my score is a little lower than the next person’s, right?” 

Consider this example: The median U.S. home sales price is $405,300. If you put 20% down, that means you need to borrow $324,240. The average 30-year mortgage rate ranges almost a full percentage point from fair credit to excellent credit, and that difference can really add up.

A 620 FICO score — solidly in the fair credit range — is the minimum standard to qualify for a conventional mortgage. Experian says the average 30-year mortgage rate for someone with a 620 credit score is 7.14%. If you borrow $324,240 for 30 years at 7.14%, your monthly principal and interest payment is $2,188.

If you’re able to bump your credit score up to 680 (good credit), the average 30-year fixed mortgage rate is 6.79%. Borrowing $324,240 for 30 years at 6.79% equates to a monthly payment of $2,112, a savings of $76 per month and $27,360 over the life of the loan.

Crossing into the “very good” credit score range with a 740 score, the average 30-year fixed mortgage rate drops further, to 6.44%. Now you’re looking at a monthly principal and interest payment of $2,037. That’s $151 per month lower than our fair credit example and $75 per month less than the good credit scenario — savings of $54,360 and $27,000 over the full terms of those respective loans.

Even though the FICO credit scoring scale runs from 300 to 850, for most financial products, the mid-700s is good enough. For something like a credit card or auto loan, there’s not usually a practical benefit to scoring, say, 800 or 780 versus 740. For mortgages, though, the high-end cutoff is 780.

The average 30-year fixed mortgage rate for a borrower with an excellent credit score of 780 is 6.25%. That brings the monthly principal and interest payment down to $1,996 on our hypothetical $324,240 loan, $192 per month less than the 620 credit score example. Over 30 years, we’re talking about a whopping $69,120 in interest savings.

A guide to improving your credit score over time

Improving your score won’t happen overnight, but it can happen over the course of several months, or better yet, years. The steps are simple:

Establish a baseline. Start by checking your credit scores and reports so you know where you stand and can correct any potential errors (they do happen!). Many banks and credit card issuers provide their customers with access at no cost. You can also utilize free resources such as AnnualCreditReport.com, Experian.com and MyFICO.com.

If legitimate negatives are dragging your credit score down, you’ll want to start right away adding positive marks to your file. Late payments can stay on your credit reports for up to seven years. Want some good news? The negative impacts are most pronounced within the first two years.

Ask for a break. You could ask your creditor for a goodwill deletion, which involves  asking them to remove a blemish because you were an otherwise reliable customer who slipped up once in a blue moon. Explain your situation and make sure to be truthful.

Sign up for the right accounts. One credit-building tool that can pay off quickly is becoming an authorized user on the account of a trusted person with their own excellent credit history. This allows you to piggyback off their long track record of on-time payments and responsible credit behaviors.

Filling your credit reports with good information can help counteract negative marks on your report. This won’t make the bad stuff go away, but it can still help. In general, credit scoring systems reward thicker credit files. The more you can show that you’ve successfully managed various types of credit, the better.

Besides signing up for a credit card that’s easy to get, like a secured card or a student card (if applicable) and using it responsibly, you could also consider signing up for a credit-builder loan. The general premise is that you set money aside each month and then you get to keep most of it at the end of the term (perhaps six to 12 months), minus some small fees. These typically show up on credit reports as installment loans, so it’s another form of credit, different from revolving credit, showing in your file.

I’m also a big fan of alternative credit monitoring systems such as Experian Boost and eCredable Lift. These can identify things that you’re already doing — such as paying rent, utilities and streaming service subscription bills on time — and pull them into your credit reports. Traditional credit scoring algorithms don’t incorporate all of these payments, so you need to do a little legwork to get them included.

Recent credit scoring changes could work in your favor 

There has been a lot of innovation in credit scoring in recent years. Government-backed mortgage lenders recently received approval to use newer credit scoring programs such as FICO 10T and VantageScore 4.0, which makes it more likely your mortgage application can benefit from things like Experian Boost and eCredable Lift. One note: These services only report to Experian and TransUnion, respectively. Mortgage lenders typically pull information from all three major credit bureaus (Experian, TransUnion and Equifax), often using the middle score for each applicant.

But one of the most impactful of these recent innovations is the introduction of trended data. That refers to credit scoring systems that measure patterns, rather than just a singular moment in time. It impacts how the algorithms measure credit utilization (credit you’re using divided by credit available to you, especially on revolving accounts such as credit cards).

Until recently, credit utilization started fresh every month. The credit scoring systems didn’t have any memory, if you will. You could be using a very high 80% of your credit limit one month but pay it down to 10% the next month and your credit score could be noticeably higher. But now, the systems incorporate up to 24 months of trended data. If your utilization is usually low but spikes once in a while, that shouldn’t hurt your score much. On the other hand, if your utilization is typically high, knocking it down one month won’t make a big difference.

This aligns with the idea that credit scoring is more of a marathon than a sprint. Credit scoring systems — and the lenders they serve — want to see a longstanding track record of on-time payments and low utilization. Therefore, seek to keep your credit card bills relatively low, perhaps showing statement balances between 1% and 30% of your credit limit and, ideally, paying these off in full before interest hits.

The bottom line

Some credit score fixes are quicker than others. Nothing spurs people like a deadline, but honestly, it’s best to give your credit score regular care and attention. I know people get busy with other things and your credit score isn’t always top of mind, but at least six months — the longer the better — before you get serious about house hunting and mortgage shopping, pull your credit reports and scores and begin making any needed adjustments.

I’ll leave you with one final recommendation: Don’t apply for any other credit during the mortgage process. Applying for a credit card or an auto loan during that sensitive time period can make lenders nervous. Prioritize the mortgage and hold off on everything else until later.

Getting the best mortgage rate can save you tens of thousands of dollars. Improving your credit score and shopping around aggressively are the best ways to nab the lowest mortgage rates.