If you are like most borrowers, you want to know what interest rate you can get on a new mortgage. The interest rate determines how much ‘extra’ you have to pay towards your mortgage in order to borrow the money. While most borrowers want the lowest interest rate possible, they don’t know what truly affects the rate they get.
Your credit score has a drastic effect on the interest rate a lender offers you. Keep reading to learn why.
What’s the Credit Score Have to do With It?
You might wonder why a lender would care about your credit score when determining your interest rate. Don’t they just give everyone the same interest rate according to the market at the time? While lenders do have a ‘base rate’ that they use for most borrowers, lenders often have reasons to increase that rate according to the borrower’s risk of default. The credit score is one of the largest factors.
Lenders often see your credit score first before even looking at your application. The credit score and report tells them a lot about you. If you have a lot of outstanding credit card debt, lenders see you as a high risk of default. If you have only a small amount of outstanding credit card debt and have all on-time payments on all of your debts, lenders see you as a good risk.
They look at the overall picture when looking at your credit. While the score is a factor, it’s not the only one. They look at everything in your history to look for patterns, if any exist. This way they can gauge your risk of default and adjust your interest rate accordingly.
The Other Factors That Matter
This isn’t to say that your credit score is the only factor that lenders look at when figuring out your interest rate. Your credit score and credit history play a role, but they are just a piece of the puzzle. Lenders look at the entire picture to decide what interest rate is right for you. A few of the factors they look at include:
- Debt ratio – Lenders compare your gross monthly income to your outstanding debts plus the new mortgage debt. They want to know that you can comfortably afford the mortgage and your other debts. Each loan program has specific debt ratios you must meet, but that doesn’t mean that lenders want you to have the highest debt ratio allowed. Instead, they want to see a low, manageable debt ratio in order to give you the lower interest rates.
- Income – Lenders look for stability and reliability when it comes to your income. They want to know that your income will continue for the foreseeable future. They also want to know that your income is consistent. This will help lower your risk of default, allowing a lender to give you a lower interest rate.
- Assets – Not all loan programs require you to have assets, this includes FHA, VA, and conventional loans. But having assets can help you get a lower interest rate. If you have enough money in savings, checking, or a liquid investment account, they can serve as reserves. This gives the lender reassurance that you’ll pay the mortgage no matter what happens to your income. This can help you get that lower interest rate.
Lenders put all of these factors together to create the ‘big picture.’ They want to know how high your risk of default is when it comes to the new mortgage. The riskier you seem, the higher the lender will make your interest rate. It works to your advantage to make sure that you have as many ‘good factors’ as possible in order to secure the lowest interest rate.