Back in 2015, Nathan and Kaitlyn Clarke were newly engaged and eager to buy an inexpensive starter home in a small town in Georgia. They were sure their combined income was more than enough to qualify for a mortgage. But then, they got a rude surprise: they couldn’t get the low rate home loan they expected because of their credit scores—or lack thereof.
Nathan’s FICO credit score was a mediocre 650 out of a possible 850. Kaitlyn, like more than 50 million American adults, had no score at all. No, the Clarkes hadn’t run up big debts or paid bills late. (In fact, they’re financially cautious types who spent less than $10,000 on their wedding.)
“Our credit score wasn’t higher because I only had one credit card at the time and no other lines of credit. My wife didn’t have any credit at all,’’ explains Nathan Clarke, who now blogs about his finances as Millionaire Dojo. Ultimately, Nathan ended up getting a mortgage in his name alone, but at a 0.5% higher interest rate than he would have paid if his score had been higher. Kaitlyn “couldn’t go on the mortgage at all, because she had no credit history. We were hoping to buy the house together,’’ he adds ruefully.
The Clarkes were unusual in buying so young (they were just 22) but the unpleasant surprise they encountered is not so uncommon, particularly for Millennial first-time buyers. As many have discovered to their chagrin, a less than stellar credit score can raise your costs to buy a house, or even prevent you from getting a mortgage.
Consider this: the average credit score is just 659 for those under 29 and 677 for those 29 to 39, compared to 747 for those 60 and older.
That’s why if you’re thinking of buying in the next few years, it pays to start thinking about—and building up—your credit score now. (We’ll have tips for all that below.)
But first, here’s why you should definitely care. You know a mortgage is probably the single biggest loan you will take out in your lifetime and that having as low of an interest rate as possible is important. But until you see the numbers, it’s hard to appreciate how big a difference your mortgage rate can make in home ownership costs—-and how much the rate you get varies by credit score.
So let’s take a look at an example using myFico’s loan savings calculator. This handy tool allows you to quickly see the estimated effect of your credit score on your mortgage rate, monthly payment and total interest paid over a 30-year-mortgage. (Keep in mind that rates change frequently and you may be to do better shopping around. But this will give you a good idea of how big an impact your credit score can have on your mortgage costs.)
Here are the FICO calculator results, run in late May, for a 30-Year $350,000 Fixed Rate Mortgage In California.
FICO Calculator Results for a 30-Year $350,000 Fixed Rate Mortgage In California
https://www.myfico.com/credit-education/calculators/loan-savings-calculator/
As you can see in the table, the FICO score has a huge impact on the interest rates and the resulting interest payments.
One thing that you might not notice at first glance is the fact that the number in the bottom right-hand corner of the table is $355,485. That’s the total interest paid by someone with a score below 640. It’s greater than the value of the original $350,000 loan and $120,000 more than someone with a credit score of 760 or more would pay.
Even if your score isn’t at the lowest end of the range, you will still feel the financial impact of a less than great score. The difference in total interest paid between a score of 699 and 760 is still more than $29,000.
Maybe you don’t plan to stay in the house for 30 years? Consider your monthly costs. In the example above, they could range from $1,626 to $1,960 depending on your score. That’s quite a spread. Now that we’ve got your attention…
How Your Credit Score Is Calculated
The reason that your credit score is important is lenders rely on it to help determine how risky you are as a borrower. While credit scores are not perfect indicators of credit-worthiness, they are the standard that is used. So for better or worse, your credit score will normally affect your mortgage rate and it’s important to understand how the score works.
Banks and other lenders regularly report consumer data to the three major credit reporting bureaus – Equifax, Experian and TransUnion. This data includes your payment history and other details from your credit cards, automotive loans and leases, personal loans, mortgages, and other borrowings. These major credit bureaus aggregate your data to compile a summary of your credit history. You credit score is based on that history.
There are five main factors that are used to calculate your FICO score. Your payment history (do you pay on time?) accounts for 35% of your score; your “credit utilization” for 30%; and the length of your credit history and age of your accounts for 15% (a downer for younger borrowers). Your credit mix and new credit applications each count for 10% each. Arguably the trickiest concept here is credit utilization—which reflects how much of your available credit you’re using on each credit card, and overall. (For more see: A 60-Second Guide To Credit Utilization.)
How To Check Your Credit Score
As recently as 15 years ago, it was nearly impossible to check your credit score without having to pay for it. Now, you can easily get it for free from many different places. I’ll share a few of them with you.
FreeCreditScore.com (owned by Experian) allows you to get your credit score for free without having to provide a credit card or other payment information. In fact, I literally just checked my credit score using the site and it was painless. You simply have to provide your name, address and phone number to get started. You will then be prompted to verify your identity and create an account. Once that’s complete you’ll get your score immediately.
Another helpful service to check your credit score for free is Credit Karma. However, note that that credit score is a VantageScore and is not your official FICO score, though they are similar. This service is available via a mobile app, as well as on Credit Karma’s web site.
Many credit card companies now also provide you with a credit score as a perk of using their cards. Some of them provide a Vantage Score instead of a FICO score, but both are typically pretty similar and simply use a different algorithm to calculate your score.
It’s worth noting that these free scores—even if they’re FICO scores–are likely not the exact scores that your mortgage lender will use. Most mortgage lenders use a much older version of the FICO scoring model in order to comply with rules set by companies who repurchase mortgages.
In order to get the actual credit score that the majority of mortgage lenders use, you would have to purchase it directly from myFICO.com for $34.89. In reality, the first month costs $4.99 and then increases to $14.95 for each subsequent month, with a 3 month minimum, hence the $34.89. However, this doesn’t mean that you should feel obligated to purchase it. You can get a solid approximation of your credit score from several places for free—and that’s certainly good enough to start working on your score now. Closer to actually applying for a mortgage, you may want to pay for the old version from FICO.
How To Improve Your Credit Score
If you check your credit score and find that you wouldn’t qualify for the lowest interest rates, it’s important that you take action as quickly as possible. It takes time to improve your score, and it is important to have it as high as possible when you apply for financing.
The number one thing you can do to improve your score is to simply make sure that you are keeping all of your accounts in good standing. Falling behind on payments is a red flag, and since your payment history is the largest driver of your credit score, it’s important to get this right. Make all of your monthly payments on time every time. Setting up automatic payments from your checking account is a good way to do this.
The next best thing you can do is to lower your credit utilization. One way to do this is to pay down your balances so that they are lower as a percentage of the total credit you have access to. If you regularly carry high balances, a lender may worry that you won’t be able to handle a new loan. Another way is to ask for a higher credit limit on the card you use most heavily.
So long as you don’t actually use any of the increased line, that too, will lower your utilization.
The next factors that affect your credit score are the average age of your accounts, your credit mix, and the number of new credit inquiries on your report. When it comes to credit accounts, older accounts are valuable because they will increase the average age of your accounts. For this reason, don’t close your oldest credit card unless you have a good reason—say, a high annual fee. Maybe a new card gives you better rewards? Fine, don’t carry your old card on a regular basis. Keeping that old, little used account open will also help lower your utilization rate.
Another possibility for lowering your utilization rate and extending the average age of your cards: ask your boomer parents, with the 800 plus credit score, to make you an authorized user on one of their credit cards—preferably one with a low utilization rate. (More, on the benefits—and risks—of becoming an authorized user is here.)
Meanwhile, if you think you may be applying for a mortgage soon, don’t apply for any other new credit so that you have fewer inquiries on your report.
A last word of advice. Even if your score is high, it’s important for you to view your credit report (as opposed to just your score) regularly to check for errors. If you see a loan on your credit report that isn’t yours, contact the credit bureau. If a lender has reported something wrong (say a late payment that wasn’t late), reach out to the lender and ask them to correct it.
No, getting your credit score in shape isn’t as interesting as researching neighborhoods or as much fun as going to an open house. But if you skip this step in the home buying process, you could be paying the price for 30 years.