The Impact of Credit Scores on Mortgage Refinancing Rates
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When you refinance your mortgage, you will have a different interest rate. The rate you receive isn’t entirely in your control. If the Federal Reserve increases interest rates, mortgage interest rates will also increase. However, you can control some components that determine your mortgage rate. Raising your credit score, which leads to a refinance, can result in better rates and terms. Once your score reaches a certain threshold, getting approved for loans and receiving competitive rates becomes easier. This guide will explore how your creditworthiness impacts your mortgage refinance rates and other loan offers.
In this article
Why lenders look at your credit score
Lenders incur risk each time they give out mortgage loans. While lenders can realize solid returns if borrowers pay their loans on time, too many defaults can wipe out a lender’s profits.
Your credit score gives lenders a snapshot of your ability to keep up with financial obligations. A high credit score indicates that a borrower is likelier to make on-time payments and not present any issues. Lenders get more competitive when trying to win over these borrowers and offer lower rates.
This is the main reason Mark Zuckerberg got a 1.05% adjustable rate for his refinance in 2012. Although rates were lower a decade ago, no one was getting a 1% APR except the ultra-rich. Lenders know there is no risk of Zuckerberg defaulting on his loan, which is part of the reason why he received that rate.
You won’t get an interest rate like that, even if you have more cash in your bank account than the refinanced loan’s balance. However, a high credit score can help you get a lower rate than most applicants.
Credit score ranges
A higher credit score leads to lower interest rates and can help you save money in many areas. You can typically get a refinance if you have a good credit score, while the best rates are reserved for people with excellent credit.
These are the FICO score ranges:
- Poor credit: 300-579
- Fair credit: 580-669
- Good credit: 670-739
- Great credit: 740-799
- Excellent credit: 800-850
It’s still possible to get a home loan if you do not have a good credit score. However, bringing up your score will give you more choices.
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What determines your credit score?
Financial transactions play a role in your FICO score, but the scoring system weighs some categories more than others. These are the five factors that influence your credit score:
- Payment history (35%). Paying your bills on time is the biggest component of your credit score. Staying on top of your expenses over many months can elevate your score to a higher range.
- Credit utilization (30%). You can improve your credit utilization ratio by getting a higher credit limit and trimming your credit card balances. Prudent repayments will increase your accessible credit and bring your FICO score up.
- Length of credit history (15%). The major credit bureaus favor consumers with credit accounts open for multiple years. This demonstrates an individual's experience managing financial obligations.
- Credit mix (10%). Having multiple types of debt and juggling them effectively can improve your score.
- New credit (10%). This component will lift your credit score if you don’t get many hard credit checks.
Minimum credit score requirements for mortgages
You will need a 620 FICO score or higher for a conventional mortgage. While VA and USDA loans have no credit score requirements, most lenders will only accept your application if you have a 620 FICO score.
Differences emerge if you want to take out an FHA or jumbo loan. FHA loans offer more flexibility for people who have bad credit. You can get an FHA loan with a credit score as low as 500.
Jumbo loans are less accommodating. Since they usually involve significant capital, they usually require 700 FICO scores or higher. Homeowners often gravitate toward these loans if the limits Fannie Mae and Freddie Mac set are insufficient for their refinance.
How much can you save with a good credit score?
Interest rates fluctuate based on market conditions and other factors, but a higher credit score will significantly impact your monthly payments. I found a 3,600-square-foot property in Raleigh, North Carolina, priced at $850,000. Using this property and data from My FICO, we can see how a borrower’s FICO score impacts their APR for a 30-year fixed-rate mortgage.
FICO Score | APR | Monthly Payment |
760-850 | 6.501% | $5,373.00 |
700-759 | 6.723% | $5,498.00 |
680-699 | 6.900% | $5,598.00 |
660-679 | 7.114% | $5,720.00 |
640-659 | 7.544% | $5,969.00 |
620-639 | 8.090% | $6,290.00 |
At the highest credit score range of 760-850, homebuyers are looking at a $5,373 monthly mortgage payment. However, the low end of a 620-639 FICO score results in a $6,290 monthly mortgage payment. In this example, the difference between excellent and fair credit scores is $917/mo.
A fair credit score ranging from 620-639 increases the monthly payment by 17%. If you could get a $3,000 monthly mortgage payment with an excellent credit score, that payment would be $3,510/mo with a fair credit score ranging from 620-639.
A lower monthly payment also allows you to penetrate the principal sooner. Making an additional monthly payment can get you out of debt faster, whether you opt for a refinance or keep your current mortgage.
Related: Pros and Cons of Refinancing Your Mortgage in Today’s Economy
How to build your credit score
Adding more points to your credit score will result in a lower monthly payment. Even if you don’t have an excellent credit score by the time you are ready for refinancing, moving your score from 620 to 680 can save you hundreds of dollars monthly.
Payment history is the most important component of your credit score since it indicates whether you can pay your loans on time. It is a good idea to avoid spending more than you can afford to repay at the end of the month.
While the minimum monthly payment will keep your payment history in check, letting your credit balance linger will hurt your credit utilization ratio. You’ll also accumulate significant interest since more credit cards have interest rates as high as 29.99% APR.
You can also become an authorized user for someone else’s credit. This strategy allows you to benefit from someone else’s good payment history. However, if this person falls behind on their bills, your credit score will take a hit. Individuals looking to rebuild credit may want to become an authorized user of a friend or family member’s credit card.
American Homeowners Could Save Big With The Help Of U.S. Mortgage Experts
If you've owned your home for 3+ years, you may be able to get cash out of your home and slash your monthly bills. It costs $0 to get connected with an expert and check your options. You'll be shocked to see how much you could save.
How long does it take to improve your credit score?
If you catch up on your credit card debt and other expenses, you won't see an overnight improvement. It can take a few months of consistent work to improve your credit.
You can only get quick gains if your credit report has errors. Requesting a free copy of your credit report from any of the three major credit bureaus — Experian, Equifax, and TransUnion — and reviewing it can tip you off on some errors. Bringing these mistakes to a credit bureau’s attention can result in corrections that improve your credit score. Mistakes may include a paid bill that shows up as unpaid.
What to do if you have bad credit
Some people fall behind on payments and have bad credit scores, leading to a refinance. While you can build your credit with the methods covered already, these other strategies apply to raising additional funds.
Get a cosigner
A cosigner is an individual who becomes responsible for making loan payments if you cannot make them. Family members and friends may agree to be your cosigner to make a refinance more accessible or secure a lower interest rate.
Lenders will prioritize the cosigner’s credit and income when reviewing your application. If you have bad credit and your cosigner has excellent credit, you will get an APR that’s equivalent to excellent credit.
Look for personal loans
Personal loans have lower barriers to entry than mortgage refinances. These financial products can come in handy if you need a few thousand dollars to cover an expense. However, you will have a higher interest rate since personal loans are unsecured.
Even though these loans tend to have lower credit score requirements, raising your score is still good. A higher credit score will give you more choices and lower interest rates.
Get a secured credit card
A secured credit card won’t do much if you need money now. However, these cards are easy to get and allow you to record positive payment history. Secured credit cards allow you to build credit, and some issuers make it easy to upgrade to an unsecured credit card once your credit score is high enough.
Other factors that determine your mortgage rate
Your credit score is key in determining your mortgage rate, but that’s not the only factor. Lenders review other components when deciding on your rate.
Down payment
Down payments don’t only apply to people who are buying properties. Some people initiate cash-in refinances where they put additional funds into the mortgage. This refinance reduces your mortgage’s balance and can result in a lower interest rate.
Loan term
Most borrowers choose between 15-year and 30-year mortgages. While 15-year mortgages have higher monthly payments, you will get out of debt sooner. On the other hand, 30-year mortgages have lower monthly payments but keep you in debt for longer. More interest accumulates on a 30-year mortgage than a 15-year mortgage.
It turns out that paying off your mortgage sooner results in a lower interest rate. There’s less uncertainty with a 15-year mortgage than a 30-year mortgage. Financial institutions offer lower rates for the 15-year mortgage. Shorter loans also have lower APRs since interest has less time to compound.
DTI ratio
DTI stands for the debt-to-income ratio. This critical metric is as important as your credit score, and lenders have maximums for this number. Most mortgage lenders do not approve borrowers' applications with DTI ratios above 45%. A DTI of 45% means that $45 of every $100 you earn goes toward debt repayment.
FHA loans have more generous DTI requirements. You can get one of these loans even if you have a 57% debt-to-income ratio. You can improve your debt-to-income by raising your income or reducing your monthly debt payments.
Loan type
You can choose a fixed or variable interest rate when refinancing a mortgage. Fixed interest rates start higher than variable interest rates, but fixed rates also offer less risk for the borrower. If you secure a fixed interest rate, your monthly payment will stay the same for the term’s duration.
Variable interest rates start lower but tend to rise over time. If the Federal Reserve continues raising interest rates, variable-rate loans will become more expensive. These loans are riskier than fixed-rate mortgages, but you will save money initially. There’s also the possibility that the Federal Reserve will reduce its rates, which would benefit variable-rate borrowers.
American Homeowners Could Save Big With The Help Of U.S. Mortgage Experts
If you've owned your home for 3+ years, you may be able to get cash out of your home and slash your monthly bills. It costs $0 to get connected with an expert and check your options. You'll be shocked to see how much you could save.
The bottom line
The difference between a 6.5% interest rate and an 8.0% interest rate can be well over $1,000 per year. Mortgage lenders look at many factors when determining which rate to give you, but few components matter more than your credit score.
A low credit score can limit your options and give lenders less incentive to give you a lower rate. However, those same lenders will compete to offer you the best rate and terms if you have an excellent credit score.
Credit building is a long-term journey that won’t resolve in a few days or weeks. However, if you stay on top of your payments and prioritize debt repayment, you can have an excellent credit score and lower rates for your financial obligations.
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Writer
Marc Guberti is a business freelance writer who specializes in personal finance, digital marketing, and entrepreneurship. His award-winning book "Content Marketing Secrets" teaches readers how to create, promote and optimize content for growth and revenue. Marc also hosts the "Breakthrough Success Podcast," where listeners learn how to master content marketing and get more clients.
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