Did you know that if your credit score is below 680, it can cost you more to get a mortgage? Knowing your credit score before you apply for a home loan is an important step for anyone who wants to buy a home.The majority of the mortgages today are either FHA loans or conventional loans. Here's the breakdown of the elements that determine the cost of your loan:FHA Loans: Despite the name, the Federal Housing Administration does not make these loans - but they do insure the lender against default. FHA loans are becoming increasingly popular because they offer a wider array of credit qualifications than a conventional mortgage, and can be especially beneficial to first-time buyers who can't afford a large down payment.An FHA loan has two forms of mortgage insurance: an upfront mortgage insurance premium (UFMIP) in addition to the monthly insurance premium. The UMFIP is amortized over the term of the loan, using 175 basis points of the initial loan amount, and the monthly premium uses 135 basis points. Essentially, an additional 1.75% will be added to your loan over the entire term, and you'll pay another 1.35% each year (divided into 12 monthly payments) in exchange for the security of FHA backing.These premiums can really add up, especially the monthly one! If your initial loan was for $500,000, you will pay an additional $8,750 over the term of your loan for the UMFIP. You will also pay $562.50 in monthly premiums. For a 15-year fixed-rate loan, this could cost you $110,000!
Conventional Loans: When you look at the added cost of an FHA loan, it might seem obvious that a conventional loan is the way to go. After all, there is no UFMIP with a conventional loan - just the monthly premium, and that will vary based on the percentage of the loan amount. However, if your credit score is below 700, you may be considered a higher risk, and that will increase the cost of your loan.To compare the difference in costs, let's look at that $500,000 loan again - in two scenarios. Both buyers have 5% to put down, but one has a credit score of 740 and the other has a credit score of 640. If the buyer with the higher credit score receives a premium based on 76 basis points and the one with the lower credit receives a premium based on 120 basis points, the difference in monthly premium payments is substantial:The first buyer (credit score of 740) will pay $316.66 a month in premiums. The second buyer (credit score of 640) will pay $500 a month. This will cost the first buyer $57,000 in insurance over 15 years, and the second buyer will pay $90,000 over 15 years. That's $33,000 more for a 15-year lease for a 100-point difference in credit scores!Buyers with lower credit scores CAN put more money down to secure a lower insurance premium, but a buyer with a higher credit score and less money to put down will typically get the better rate.What Can You Do?1. Make sure you know your credit score before you decide on a mortgage option. If your credit score is below 700, research options to improve your score - and go over the report with a fine-toothed comb to look for discrepancies or mistakes that may be costing you money.
2. Consider your down payment. If you can't afford to put at least 20% down on a home loan, you will need to pay the monthly mortgage insurance premium. You may want to consider a less-expensive house so that you can stretch your down payment further.
3. If you can't put 20% into a down payment, take a look at your long-term budgeting. Calculate the additional cost of your premium to make sure you can afford the monthly cost of a mortgage. Do you have enough income to cover this new payment in addition to your other debts and expenses?
No matter what you're looking for, there are mortgage professionals who can help you find the best loan options. Work with someone who knows the ins and outs of the mortgage industry so they can help you predict payments for different types of loans, and can help you decide on the best strategy for a long-term mortgage.