How Credit Affects Mortgage
Everybody knows the three most important things in real estate are location, location, and location.
However, many more factors impact your ability to secure a mortgage, such as the value of your desired home, your current assets, and your credit history.
Before you apply for a mortgage, you should have a complete understanding of how your credit score affects your mortgage, what factors contribute to your score, and how you can best prepare to apply for a mortgage. This guide talks about the steps to protect your financial future and how to secure the best possible mortgage rate.
Reasons Your Mortgage Application Could Change
There are many reasons your mortgage application could change—some have to do with your credit, while others don’t. Understanding how your credit score impacts mortgage rates, you can take the necessary steps to ensure that your credit is never the limiting factor in the rate you qualify for.
Mortgage rates change over time in response to market demand, monetary supply, and housing availability. High mortgage rates tend to motivate people to stay in their houses longer, while low mortgage rates make buying a new house that much more attractive.
While the difference between 3% and 6% may not sound that significant, doubling your interest makes a major difference in how much you end up paying over the lifetime of your loan. An increase of just 0.1% can amount to tens of thousands of additional dollars you’ll pay over the loan’s lifetime, depending on the value and term of your loan.
Credit Utilization Ratio
Financial institutions utilize credit reports because they show a complete timeline of your credit activity. If your credit report indicates that all your accounts are in high balance, that means you’re less likely to repay your debts and thus present a higher risk to the institution.
High credit utilization lowers your credit score, whereas using less of your available credit raises your score, so a high credit card balance can affect your mortgage application.
Average Age of Credit
Ideally, lenders want to see long, positive credit history. When a borrower opens a large number of recent accounts before applying for a mortgage, that’s a red flag to lenders that the borrower might be borrowing beyond their means. An older average credit age raises your credit score, so experts suggest that you never cancel your oldest credit accounts and avoid opening too many new accounts.
Delinquency, Collections, and Bankruptcy
A history of late payments (delinquencies), collection activity, or bankruptcy are major red flags to financial institutions. While each lender has their own underwriting guidelines, these types of negative history can affect your ability to secure a good mortgage rate for years down the line. Because this history stays on your credit report for several years, the best strategy is to avoid late payments, collections, and bankruptcy in the first place.
A major factor in your mortgage rate is your loan-to-value ratio (LTV). A high LTV ratio means your mortgage is a relatively high amount compared to the value of the home, while a low LTV means you’re paying a larger downpayment and borrowing less of your home’s total value.
Your LTV doesn’t directly affect your credit score, but lenders may consider your credit score when determining what LTV they’ll approve. In general, the higher your credit score, the higher your LTV can be before it starts affecting your mortgage rate.
Tips to Prepare Your Credit for Mortgages
Buying a home is a major life event, so you should maximize your chances of success. Follow these steps to give yourself the best odds of securing a favorable mortgage rate:
Check Your Credit History and Current Score
Take a few minutes to become familiar with your credit report—the number of open accounts, their balances, any late payments or collection actions, and derogatory and disputed accounts. Knowing and understanding your credit report is one of the best ways to proactively improve your approval odds.
Platforms like NerdWallet can help you evaluate your credit by breaking down the factors that contribute to your score and recommending some next steps to improve it.
Pay Your Bills in Full and On Time
Credit card debt does not necessarily make a mortgage loan impossible, but it does make it more difficult. Paying your bills on time and in full is the best way to improve your credit score and the best way to get approved for a favorable mortgage rate.
Your credit card balance is a significant factor in your mortgage application, so try to maintain low credit card balances from your initial application until you close on your new house.
Avoid Opening New Credit Cards and Accounts
Opening accounts like credit cards and personal loans are essential for improving your credit score, but you should avoid opening new accounts within a year of applying for a mortgage. Any hard inquiries from the last 12 months can potentially work against your credit score.
Pay Your Debts and Check Your Debt-To-Income (DTI) Ratio
Your Debt-To-Income (DTI) ratio is the percentage of your income that you spend on obligations (such as rent, credit card debt, existing mortgages, etc.). For instance, if you make $50,000 a year but spend $40,000 paying down debts, you have a DTI of 80%. Meanwhile, if you only make $20,000 a year but only spend $5,000 on debts, you’d have a significantly better DTI of only 25%.
You can improve (decrease) your DTI by paying down your existing debts and avoiding new ones or by increasing your income.
Next Steps with Arkansas Federal Credit Union
Maintaining a positive credit score is essential for securing a favorable rate, but credit isn’t the only component of a good mortgage.
Just like financial institutions are using your credit report to evaluate your experience and reputation, you should consider the experiences and reputations of the financial institutions in your area.
Arkansas Federal Credit Union (AFCU) has a long history of serving Arkansas residents and workers through local lending and servicing. As one of the largest and best-trusted mortgage lenders in Arkansas, AFCU can help you with every step of your mortgage journey.Get a mortgage quote to learn more about how AFCU is serving your community.