Published December 2, 2016|6 min read
This article originally appeared on Earnest.
If you’re considering buying a home, you’ve probably played with a few online calculators or noted the compelling mortgage interest rates advertised on billboards, banner ads, and bank branch placards.
But will you actually qualify for those rates?
It’s a smart question. If you’re new to the mortgage market, there are two kinds of mortgage interest rates: There is the best-advertised rate, and then there is the slightly different rate you may pay based on factors including your credit score, loan size, and home purchase price.
So what exactly is the best-advertised rate? It’s that 3% 30-year fixed loan marketed in your bank branch that looks really good—until you squint to read the signboard footnotes explaining that to get it you’d need an 800+ FICO score, 30% down payment, and dozens of additional criteria to qualify.
Here’s a look at several factors that can impact your borrowing power and how lenders apply them to mortgage decisions. You may not be able to change some factors—for instance, it can take many months to improve a depressed credit score—but understanding them can help you set expectations.
As much as 1.7%. In other words—it can have a major impact on how much you pay.
You probably already know that your FICO credit score will influence your mortgage loan interest rate and thus how much of your housing payment goes toward principal versus interest. Paying high interest can lower your borrowing power and may mean you build home equity more slowly than other homeowners. And having too low a FICO score can restrict the field of loans available to you.
FICO scores range from 300 to 850. Norms for the lowest score at which it’s possible to borrow for a mortgage vary, but historically borrowers need to produce scores at or above 680 to have decent options. Borrowers with scores above 760 are generally in the top tier among borrowers, thus there’s not much point working to boost your score just for the sake of mortgage rates.
Using this calculator, you can see how FICO scores can impact your monthly payments on a property. With a $300,000 home loan (this is not the home’s price but the amount borrowed in the home purchase), your interest rate could be as low as 3.3% and your monthly payment could be $1,315—or as high as 4.9% for a monthly payment of $1,591. That’s a $276 monthly or $3,312 annual difference!
In this example, borrowers with the lowest payments had the highest credit scores (at or over 760), while borrowers with the highest payments had the lowest credit scores (620-639). It’s unclear what borrowers with scores below 620 would pay.
Bottom line: Having a very low credit score (closer to 600) and paying thousands extra in interest can add up over five or 10 years in a home. However, in this example, having an A- or B+ score (700-759 range) costs only $30 more per month than having an over-achiever’s credit numbers (760+).
This factor can influence your rate up to another 0.5%.
Aside from your credit score, lenders also look at your loan size in a couple of ways. Not only do they look at the dollar amount of your loan, but they also look at a metric known as your loan to value (LTV), or what percent of a home’s sale price you are borrowing. This is a number expressed as a percentage.
Take a $500,000 house: If you put $100,000 down to buy the home (a 20% down payment) and borrowed the remaining $400,000 (80% of home’s sale price), then your loan ($400,000) to value ($500,000) would be 80% because the loan is 80% of the home’s value. Lenders prefer to see an LTV of 80% or below.
Lenders can also adjust loan rates up or down based on a combination of your FICO score and loan to value. Generally speaking, the higher your loan to value the higher your mortgage interest rate will be.
However, the interest rate uptick applied for having a high loan to value will typically be steeper for a borrower with poor credit than for one with good scores.
Some popular loan programs for first-time buyers—FHA loans, VA loans, and USDA loans—do allow high LTV. These programs accept very low down payments of 0% to 3.5%, meaning these are loans where it’s possible to see 96.5% to 100% LTVs. While these loans permit high LTV rates, the catch is that there are typically low loan maximums—thus you can’t necessarily use one of these programs to finance a luxury property. In addition, you’ll also have to buy private mortgage insurance (for borrowers who make a down payment below 20%).
Last but not least, the dollar amount of your loan may play a separate role in what sort of interest rate you get. If you’re buying a whole lot of house or are shopping for a home in a market where home prices are much higher than the $240,000 national median home list price, you may need to seek out a so-called "non-conforming" or JUMBO loan.
A jumbo loan is one where the borrowed amount exceeds $417,000—or, in some pricier markets (think cities) a loan exceeding $625,000. Because such loans are large for their region or metro area, lenders may place special requirements on them (demanding a higher credit score or certain down payment).
It’s important for borrowers to familiarize themselves with their particular market’s dynamics with respect to JUMBO loans and whether or not they may need to apply for one. Here’s a resource for finding out JUMBO loan balances in your geographic area. If you think you may need a JUMBO loan, keep in mind that if you’re shopping on the outskirts of a metro area you may want to double-check zip codes to see whether or not potential future homes would need to be financed with these loans.
Borrowers also need to know that small differences in home price or down payment can nudge them into JUMBO territory. For example, if you’re looking at a $475,000 home and want to put down 10% ($47,500), your loan would be $427,500—a JUMBO. If you were eyeing a $450,000 home and planned to make a 10% down ($45,000), you’d borrow $405,000, beneath the JUMBO threshold.
There are many loan programs out there, both within a single lending organization and across the lending industry. Before setting your sights on a particular home, it’s important to understand how your credit score and the mortgage market function so you can qualify for a mortgage that works for you.
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