The mortgage market is loosening up a bit, and you're hoping to become a new homeowner while interest rates remain at a historical low. Before perusing the listings, experts suggest brushing up on how your credit score drives the amount of money you'll need to pony up to qualify for a mortgage or get through closing. And adding one or two points to your credit score can save you hundreds -- or more -- at closing.
In addition to determining whether you score a good interest rate, upping your score by even a few points can bump you up to a threshold that will allow you to put less money down. "As little as one point can make the difference between being approved with only a 10 percent down payment versus needing to put 15 or 20 percent, or more, as a down payment," says Eugene Hedlund, a mortgage broker based in Irvine, California.How Low Can You Go?
Doug deBruyn, a certified mortgage planning specialist in Bellevue, Wash., says the lowest your score can dip to qualify for any mortgage is 620. "That score will let you go with an FHA, government-backed loan, which requires no less than 3.5 percent down." But he cautions "conventional loans" aren't as liberal as their FHA counterparts. You typically need at least 10 percent down; more if your credit is shaky. "One of my lenders will underwrite a 680 score with less than 20 percent down while another might consider a score of 660," he says. "But those might carry a much higher interest rate than if a person's score was in the 700s."
That's because when lenders underwrite loans, they do so with the intention that the loan will be attractive to Fannie Mae and Freddie Mac. "Fannie and Freddie purchase loans, and are far less willing to purchase risky loans than they once were," says deBruyn. These players prefer transactions that already have some equity in them. "Fannie and Freddie don't like a loan-to-value (LTV) ratio greater than 80 percent," deBruyn explains. "If your credit isn't up to snuff, lenders might want an even lower LTV to entice Fannie and Freddie." So you may have to come up with a bigger down payment.
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Your credit also dictates the interest rate at which a lender is willing to give you a mortgage. Hedlund says to get a rate that you can afford, "you might have to cough up additional money at closing for 'points,' which borrowers can pay to the lender to secure an attractive interest rate." One "point" is equal to one percent of the loan, and Hedlund says those points can add up rather fast. "One point of a $200,000 mortgage is $2,000. Two points is $4,000 on top of other closing costs needed."
The lower the credit score, Hedlund says, the more money you'll either need to put down or pay in points. "Any score below 740 will have a direct impact on how much money you'll need at closing." For example: To qualify for an interest rate of 5.25 percent, an average credit score of 670 would be assessed one point if putting 30 percent down, two points with 25 percent down, and 2.5 points with 10 to 20 percent down. "Those points can add up to a lot of additional money needed at closing," Hedlund says.The ABCs of PMI
One more way your credit score matters is when you're trying to secure PMI (private mortgage insurance), which is required when financing more than 80 percent of a home's value. DeBruyn says to qualify for PMI in this market, you need a score of 700 in all states (except in Florida, where you need a 720) for any loan with less than 20 percent down, with a minimum down payment of five percent. "If putting down more than 20 percent (to avoid paying PMI), the minimum credit score is 620," he adds.
Hedlund notes whether you're "just looking" or seriously shopping for a mortgage, it's best to know your credit score. "Talk to a mortgage specialist to understand your options and what percentage of a down payment you're likely to need before finding a house to avoid hitting any snags once you've fallen in love with a property."