How your credit score affects your mortgage loan?

Summary: Find out which role credit scores play in determining whether or not your mortgage loan is approved and at what interest rate.

Today, credit scores play a big role in determining whether or not your mortgage loan is approved and at what interest rate. Obtaining a mortgage loan at an interest rate just one point less results in a savings of about $5,000 on the average 15 year mortgage, and significantly more on a 30 year mortgage (about $50,000).

If you've ever wondered how mortgage lenders decide whether to offer you a mortgage, the answer lies in your credit rating. Why do lenders use your credit score in their lending decisions?  Because they discovered that there is a direct correlation between your credit score and the odds of your becoming delinquent on your monthly mortgage payments.

Who determines your credit score? Credit bureaus collect data from your lenders about your history of borrowing and paying back credit. They compile that information into your credit report, which any lender can access whenever you apply for a loan. The Fair Isaac Corp. is the major producer of credit scores. They take the information from those credit reports, apply their own trade-secret formula and, based on the three credit reports, distill three credit scores for you into one score ranging from 300 to 850. 

Which parts of a credit history are most important?

You can use these percentages as a guide:

35% - Your Payment History
30% - Amounts You Owe
15% - Length of Your Credit History
10% - Types of Credit Used
10% - New Credit

If you are not satisfied with your credit score, there are steps you can take to raise your credit score or overcome a low credit score:

(1)  Offer a larger down payment so that you aren't borrowing so much money

(2)  Lower your debt-to-income ratio by paying off as much debt as you possibly can before applying for a mortgage loan in order to increase your credit score

(3)  Don't buy a car just before applying for a mortgage loan as it lowers your credit score

(4) Improve your credit rating

While scores are important, they are not the only thing lenders take into consideration when approving a mortgage. And low scores aren't insurmountable obstacles. Other "offsetting factors" can balance a low credit score, such as a large down payment, large cash reserves or an overall low debt-to-income ratio. The important thing is that borrowers not assume they can't get a mortgage because of a low credit score, or that they limit their loan search to lenders that specialize in loans to people with troubled credit.

But also we want to stress the importance of not only doing all you can to improve your score, but shopping thoroughly when looking for a mortgage. From the perspective of a mortgage broker, who can choose among a sea of many lenders, there are no sharp break points. Consumers should do what a good broker does -- look for a lender that offers the best rate for a specific score.