Higher Scores = Savings on Mortgages

Higher Scores = Savings on Mortgages

From grade point averages in school to sports statistics, numbers let others judge our ability and value. The same is true if you’ve ever applied for a credit card or a loan. Banks calculate how much debt they think you can handle based on your income and prior credit history. Low numbers are only good for golf and running races, not for getting lines of credit.

Low credit scores have painful consequences. Let’s say you’re interested in buying a home. Maybe your credit history has a few dings in it—student loan payments that got behind, a car that was repossessed…you had a couple of bad years with your finances. The economy’s been rough over the past decade, lots of people suffered, you’re not alone in this.

You went to your bank to check out interest rates and a down payment. The bank pulled a tri-merge report and looked at your credit score. Based on that number, they either gave you an offer…or not.

Let’s back up and see what they are using to make this judgment call. What is a tri-merge report?

3-in-1 credit score

The three big credit bureaus, Equifax, Experian, and Transunion, each have their own record of your credit history. (You can see them all for free at annualcreditreport.com.) You may notice that not every bureau shows the same information.

These reports don’t always show your FICO score, but that’s the magic number that factors in here. The actual FICO formula is a trade secret, but the general calculation is as follows:

  • 30% based on how much you owe
  • 35% depends on how well you’ve paid on time
  • 15% on how long you’ve had lines of credit open
  • 10% on whether you have a variety of creditors
  • 10% based on if you have recently opened accounts

Mortgage lenders get reports from all three credit bureaus and use the median score to calculate your offer. Median here means the score in the middle, not the average. So let’s imagine that Equifax says 600, Experian says 620, and Transunion says 650. You’re stuck with 620.

Consequences of a score

What are the consequences of a score? My favorite international soccer team won almost every game this year, but still lost the national championship. Their final overall score was only two points below the next closest team, even though that other team lost more games. It’s just as frustrating with credit history. Low overall scores hurt even if you’ve had some wins. Banks want borrowers that show consistency.

Let’s look at rates for a 30-year fixed rate mortgage of $200,000. That’s just a little above the average price of an American home today. We’ll calculate using the median score of 620 and compare what happens with a higher score of 640. You may be shocked at the difference.

Score of 620 Score of 640
Interest Rate 5.265% Interest Rate 4.719%
Monthly payment $1,106 Monthly payment $1,040
Total interest paid over 30 years

$198,256

Total interest paid over 30 years

$174,242

Total interest savings because of a higher credit score:
$24,014

Calculations based on http://www.myfico.com/crediteducation/calculators/loanrates.aspx

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