Here are three facts about mortgage applications that at first glance are difficult to reconcile:
Fact 1: Mortgage rates are at historic lows.
Fact 2: Real Estate prices have fallen substantially over the past few years.
Fact 3: The number of mortgage applications over the past 2 months are DOWN.
So what’s going on here? Well, according to the WSJ, part of the problem is persistent unemployment. Rates and prices can be low, but if you are looking for work, you won’t be buying a home or refinancing a mortgage.
But there is a second problem that has persisted for several years–low credit scores. According to Fair Isaac, the creator of the FICO credit score, about 25 percent of consumers who have active credit files (about 43 million people) have FICO scores of 599 and below. Here’s a chart from FICO Banking Analytics Blog showing the shift over time:
And for most mortgages, a score of 599 won’t qualify you for a mortgage.
Now, we’ve already covered what credit score you need to get a mortgage. But there are still two unanswered questions. First, what credit score do you need to qualify under Fannie Mae’s guidelines (which most mortgages must meet)? And second, even if you qualify, how does your credit score affect what you’ll pay for the loan?
Let’s take a look at both of these questions.
What credit score do you need to meet Fannie Mae’s guidelines?
Fannie Mae publishes a series of matrices setting out fairly complicated rules on pricing loans. These rules include not only credit score requirements, but also loan-to-value (LTV) rules. LTV is important because in combination with your credit score, it can result in higher or lower interest rates and in some cases determine whether you will qualify for a mortgage at all.
Perhaps the most common mortgage is for the purchase of a single-family home. Subject to some exceptions, your credit score must be at least 620 if your LTV is equal to or less than 75%, and 660 if your LTV is greater than 75%. The same guidelines apply for what is called a limited cash out refinance (LCOF).
How does your credit score affect the closing costs of the loan?
This is where things really get interesting. Fannie Mae breaks credit scores into eight categories. For each category, it then provides varies LTVs. For each credit score/LTV combination, Fannie Mae provides what it calls a Loan-Level Price Adjustment (LLPA), which ranges from -0.25% to 3%. This means that depending on your credit score, down payment, and other factors, you could be paying up to 3% more on your loan.
The “good” news is that you can choose how you pay these additional costs. You can choose to pay the fees at closing in the form of points. Or the costs can be baked into your loan, increasing the interest rate you pay. If you choose a higher interest rate over points, each 1 percent in LLPA will increase your interest rate by 0.250%. Either way, if you trigger a LLPA, you’ll pay the price.
There are several charts published by Fannie Mae showing the various credit score/LTV combinations. Here’s an example of one (click to enlarge):
So what’s the takeaway here? First, as we’ve said many times before, your credit score is really important. A good score of at least 720 (and preferably higher) will save you thousands of dollars in mortgage interest. Second, there is no reason to worry about a “perfect” credit score. The chart tops out at 740.
Third, don’t be fooled by advertised mortgage rates. The ads always show the lowest possible rates. Depending on the terms of the loan and your credit score, however, your rate could be higher. And finally, the Fannie Mae guidelines are extremely complicated. We’ve only scratched the surface here. So if you are in the market to buy a home or refinance, check with a mortgage broker who can walk you through all the rules and let you know the best mortgage rates available for your specific circumstances.