Who would have thought that a three digit number would make such a difference?
- Working on your credit score before applying for a mortgage is crucial to saving money on a home purchase.
- The better your credit score, the lower the interest rate you will qualify for.
- You can increase your credit score by paying down debt, improving your payment habits, and removing errors from your credit report.
If you’re looking to buy a home sooner rather than later, you may have a to-do list that includes items like finding the right real estate agent, narrowing down the neighborhoods you want to look in, and even researching potential mortgage lenders. But there’s one big task you want to add to your list: improving your credit score.
Personal finance guru Humphrey Yang recently demonstrated the importance of having good credit and being a trusted borrower on Instagram by talking about two different prospective home loan applicants with different loan histories. The one who missed a loan payment was given a much higher monthly payment (including interest) than the one who paid a previous loan on time. This resulted in the strongest credit borrower paying $137,000 less in interest over the course of the mortgage term! I don’t know about you, but $137,000 is a lot of money to me.
Let’s take a closer look and break this down into real numbers to see what a higher credit score can do for you in your home buying quest.
A tale of two credit scores
Let’s say you are applying for a home loan and have a credit score of 620. This is the minimum acceptable credit score to be approved for a conventional home loan (meaning one that is not backed by the government like an FHA or VA loan would be). ). to be). The amount you borrow is $350,000, and you get a 30-year fixed-rate mortgage, which is “the best thing in the world,” according to Warren Buffett. With your credit score of 620, at the time of this writing at current mortgage rates, you would be looking at a monthly payment of $2,535 and paying a total of $562,538 in interest on your mortgage.
But what if you approached the process with a credit score of, say, 700? You’ll qualify for a lower interest rate (since lenders see you as a less risky borrower), giving you a monthly payment of $2,211 and leaving you paying $446,074 in interest, or $116,464 less than in our first scenario.
How to improve your credit score
It’s easy to see from the numbers above just how advantageous a higher credit score can be if you’re hoping to save money on your home purchase. And let’s face it, owning a home is already expensive enough. So what can you do to get your credit in top shape before applying for a mortgage?
More: Check out our picks for the best mortgage lenders
- Pay the debt: Really dig in and focus on paying off your existing debt, especially if it’s high interest, like credit card debt. This, in turn, will free up cash to save for a down payment and improve your debt-to-income ratio, another number you’ll want to be as low as possible to get approved for a mortgage.
- Improve your payment habits: Your payment history accounts for 35% of your credit score, so if you’ve historically fallen behind on payments, now is a good time to improve your payments on time.
- Check your credit report: Errors on credit reports are fairly common, so it’s worth checking yours (you can access your credit report for free every week until the end of 2023) and see if there are any errors. If you find any, you can ask to have them removed.
While you might not like the idea of having one more thing to do as you prepare to buy a home, improving your credit score really should be a priority. Having a better score will save you money in mortgage interest and make you a more attractive borrower to mortgage lenders. And that’s not worth it?