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How your credit scores affect mortgage rates

We all know that your credit scores affect mortgage rates. But your credit history can also affect how much you have to put down and the price you pay for private mortgage insurance (PMI). It's not impossible to buy a home with damaged credit; it's just much more expensive. Here's why.

It’s no surprise that your credit scores are instrumental in getting approved for a mortgage. Even so, you may not realize just how many ways your credit scores affect mortgage rates and all aspects of the mortgage application process.

Your credit scores affect the kinds of mortgages you can be approved for, how much you can borrow, the mortgage rates you’ll pay and even how much you’ll pay for private mortgage insurance.

When it comes to conventional financing at least, you will be required to have a credit score of at least 620 in order to be eligible for a loan. The higher your credit score is beyond that, the better the terms will be.

This is why it’s so important to understand your credit score in the months before you apply for a mortgage. If you do have impaired credit history, you’ll want to work to improve your credit scores before you even apply. And if you already have good credit, you’ll want to keep it as high as possible by avoiding taking on other new debt.

Let’s take a look at some of the ways your credit scores affect mortgage rates (and everything else in the mortgage world!)

Risk-based pricing

Mortgage lending is largely based on risk-based pricing. That means that lenders will increase the cost of your mortgage for just about every risk associated with your credit profile. The lower your credit score is, the higher the rate that you will pay on your mortgage.

The difference between a 625 credit score and a 750 score could add a half a percent to the rate you will pay for your loan.

A 750 credit score could qualify you for a $200,000 30-year mortgage, at a rate of 3.625%. That translates to a monthly payment of $912.

With a credit score of 625 however, your rate would be 4.125% for a mortgage of the same size and term. This would result in a monthly payment of $969.

The 625 credit score will result in a monthly payment that’s higher by $57 per month. If you multiply that by the 360-month term of the mortgage, you’ll be paying $20,520 extra over the life of the loan. That’s about the price of a modest car at today’s prices.

Use our Loan Payoff Calculator to see how different payments and interest rates affect your loan.

And when you’re ready to start shopping, you can get personalized rates (with no obligation) from multiple mortgage lenders after answering a few simple questions with our partner, Mortgage Research Center.

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Credit history can affect your loan-to-value ratio (LTV)

Beyond pricing, credit history can sometimes affect how much you can borrow on a given property. In the mortgage industry, this is referred to as “LTV”, or loan-to-value ratio. It’s the percentage of a property sale price – or appraised value in the case of a refinance – that you will be able to borrow up to. If you qualify for a 95% LTV, that means you can get a loan of $190,000 on a sale price of $200,000.

Under certain loan programs, mortgage lenders will limit how high they will go on the LTV if your credit scores are below a certain level. This is especially true on what are referred to as “non-conforming” loan products. This includes jumbo loans – loan amounts that are in excess of standard conventional loan limits.

For example, while a lender may permit you to borrow up to 95% of the property value if you have a 750 credit score, they may restrict you to no more than 80% of the property value if your credit score is 650.

You may be prohibited from certain programs

If your credit history is significantly impaired, a lender might exclude you from being able to participate in certain loan programs at all. And where conventional financing is concerned (Fannie Mae or Freddie Mac loans), you won’t be able to get a mortgage and all if your credit score is below 620.

Once again, the situation is more pronounced when it comes to non-conforming loans. Since non-conforming loans are issued by non-agency lenders – meaning not Fannie Mae or Freddie Mac – the lenders can set their own rules. Some do prohibit making loans to borrowers with credit scores below a certain level.

This can be especially true when it comes to loans to purchase investment property, or even second homes. Since both property types involve additional risk to the lender, the lender may decide to extend mortgages on such properties only when the actual credit risk is minimal. A low credit score could leave you completely ineligible.

Credit scores can determine the leniency of underwriting

Unfortunately, when it comes to mortgages, your credit history is not a stand-alone issue in the approval process.

A strong credit history can allow lenders to be lenient in other areas where you may be weak, such as income, down payment and cash reserves. Conversely, a poor credit history almost guarantees that the lender will strictly adhere to the published requirements in these areas.

For example, if your employment history is weak or your income level is not quite where it should be for the loan you are applying for, the lender may still approve the loan if you have a credit score above 750. But if your credit score is 650, they may decide that the combination of the high credit risk along with the income weakness represents an unacceptable loan risk overall.

The higher your credit score is when you apply for a mortgage, the more flexibility you’ll have with the lender on other requirements like length of employment and down payment.

Credit scores can also affect private mortgage insurance (PMI)

Though it doesn’t get nearly as much coverage, your credit history can also affect the rate you will pay for private mortgage insurance (PMI).

Lenders require you to carry PMI if you make a down payment that is less than 20% of the purchase price of the property (or your equity is less than 20% on a refinance). PMI insures the lender in the event you default on the loan.

But PMI companies also take credit history into account in calculating the cost of that insurance. For example, using monthly PMI rates for MGIC, you will pay a rate of .54% for a 95% loan with “30% coverage“ – if you have a credit score of 760 or greater.

If you have a $200,000 mortgage, this will work out to be $1,080 per year, or $90 per month added to your monthly mortgage payment.

But if your credit score is 679 or less, the rate for the same coverage on the same mortgage will be 1.15% per year. This will work out to be $2,300, or about $192 per month added to your monthly mortgage payment. That’s more than twice the cost of mortgage insurance with the higher credit score.

Keeping all of this in mind, you will do much to improve your future financial situation by doing your best to improve your credit history before applying for a mortgage. A difference of 100 points on your credit score could literally cost you — or save you — thousands of dollars per year.

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