Most people know that mortgages are driven by your credit score, but they are affected by them more than you might think. Every loan program has a minimum credit score they will allow in order for you to qualify for the loan, but it does not end there. Even if you meet the minimum requirement in order to get approved, the actual score will determine many other aspects of your loan including the amount of the required down payment, your interest rate, and the amount of private mortgage insurance you must pay.
Down Payment Requirements
Every loan program has a different down payment requirement. For example:
- FHA loans require at least 3.5 percent down on the home
- VA loans do not require a down payment
- USDA loans do not require a down payment
- Conventional loans require at least 3 percent down on the home
Knowing the minimum down payment requirements is not enough, however. For example, if you apply for an FHA loan and you have a credit score of 550, you are eligible for the program, but you are not eligible to put down just 3 percent. You will need to put down at least 10 percent in order to qualify for the loan despite any compensating factors you may have.
Other loan programs also require you to put down higher down payments that directly correlate to your credit score. Every bank will differ in what they require. For example, a 680 credit score might be perfectly acceptable for one bank, allowing you to put down just 3 percent for the Fannie 97 loan. Another bank, however, would not find this acceptable and would require you to put down at least 10 percent in order to make up for the riskiness that your lower credit score provides. When you put down a higher down payment, you have “more skin in the game.” This means that you have more invested in the home and are more likely to make your payments no matter what. On the other hand, if you had just 3 percent invested, it would be much easier to walk away.
Interest Rate Adjustments
The interest rate you obtain on your mortgage is dependent on a wide number of factors. Of course, the market has the largest impact as every interest rate starts somewhere. On top of the basic interest rate, however, are the adjustments that the lender requires in order to make up for the riskiness of your individual loan. In general, the lower your credit score; the higher your loan-to-value ratio; and the higher your debt-to-income ratio, the higher your interest rate will be. Every lender differs on what adjustments they make for each situation, but generally, a lower credit score tends to give the interest rate the hardest hit. The lower your credit score is, the more likely it is that you are not as financially responsible as the lender would prefer. If they choose to give you the loan, they are going to need to make up for that riskiness by charging you a higher rate.
Private Mortgage Insurance Increases
You are required to pay private mortgage insurance if you put down less than 20 percent on any loan. Most loans have some type of insurance that you must pay in order to back the lender up in the face of default, with the exception of the VA and USDA loans. The private mortgage insurance you pay on conventional loans, however, is directly related to your credit score. The amount of PMI you pay is directly related to your risk level. The less money you put down, the higher rate you will pay. In addition, the lower your credit score, the higher your PMI rates will be as PMI directly correlates to the risk level of your loan.
Having a lower credit score does not always mean you will not get a loan. If you are able to secure one, you will have to pay for it in ways that someone with good credit would not have to pay. Generally, that is in the form of the interest rate, private mortgage insurance, and the amount of the down payment required. Every lender is different, however, so make sure to shop around to see what others are offering to ensure you are getting the best deal on your mortgage.