As a nation we obsess over credit scores. Once hidden in the computer terminals of banks, they’re now freely available to you via many providers on the Internet. But in reality, getting a loan takes into account much more than just your score. And nowhere is that more clear than when you try to get a mortgage or refinance an existing one.
The process is usually murky, but a recent survey of loan officers by FICO sheds some light on what really matters.
The survey asked what factor would make a loan officer most hesitant to approve a mortgage, and the number one answer took the lead by a wide margin:
- High debt-to-income ratio 59%
- Multiple recent applications 13%
- Low FICO score 10%
- Frequent job changes 9%
- Lack of savings 8%
Debt to income is the biggest thing mortgage lenders look at, much more than your FICO score itself.
Why is debt to income a bigger factor than your score?
Nothing is more important than being able to afford a loan. What you pay every month toward your house and other obligations compared to what you earn is the most important factor. A FICO score only tells whether you are a reliable payer, not whether you can afford a house.
The loan officer can look past a less than perfect FICO score if you’re buying a house you can truly afford.Being able to afford a house means keeping your debt to income below 36 percent when counting all of your monthly debt obligations, including credit cards, car loans, student loans, and your housing expenses.
Officially, conforming loans can be had with debt to income ratios as high as 45 percent or so, but that’s cutting it close unless you have substantial savings or bonuses that don’t get counted in the income calculation. But really, you shouldn’t be going any higher than approximately 35 percent.
Think about it this way.
If you’re pulling in $5,000 a month before taxes, a 45 percent debt to income ratio means you’re paying $2,250 a month servicing your mortgage and other debt. With a 35% tax rate you’re left with just $1,000 in cash a month left over for other expenses.
Yes, you get a tax benefit at the end of the year for deducting interest, but the reality is you’re house poor, even with a perfect credit score.
At a 35 percent debt to income ratio you’ll have $1,500 a month in cash for your other expenses. That’s 50% more left to spend than with a 45% debt to income ratio. Do this math at least three times before deciding how much of a mortgage you can really afford.
Just because you qualify for a big mortgage doesn’t mean you will want to live with it.
Will a better score help at all?
Your credit score can help some, but don’t expect a lot of relief.
Here is a national sample of mortgage rates by FICO score at the time of this article collected by Informa Research Services on behalf of FICO:
- 760- 850: 3.785% $1,860 / month
- 700-759: 4.007% $1,911 / month
- 680-699: 4.184% $1,952 / month
- 660-679: 4.398% $2,003 / month
- 640-659: 4.828% $2,105 / month
- 620-639: 5.374% $2,240 / month
The difference between a marginal excellent credit score (700-759) and a truly excellent one (760+) is about $50 a month on a $400,000 mortgage. That’s $600 a year, and $18,000 over the life of the mortgage.
The key here:
Be careful about what other credit you apply for before you apply for a mortgage.
Loan officers don’t want to see a lot of recent credit applications, and each one can temporarily ding your score five or 10 points. So if you’re on the borderline of 760, 700, or 680, it’s best to avoid opening any new credit accounts for about 6 months before a mortgage.
Otherwise a couple of cards could end up costing you $18,000 in extra payments on your mortgage.
And if you have a borderline score, pay as much debt off as you can before applying.
It will help your debt to income ratio, and improve your score. Just make sure you do it at least a month before applying, as banks typically report data to the credit bureaus only once a month.
And don’t be afraid to shop around for the best mortgage rate: just make sure you do all of your shopping in a short period of time for the smallest impact to your score. Multiple mortgage inquiries during one shopping period (typically 30 days or less) only counts as one inquiry on your credit report.
If you only have a 10% down payment and want to avoid PMI, consider SoFi. You can quickly and easily find your rate on SoFi’s website. Even better: SoFi does not obsess over FICO, especially if you are a younger borrower with limited credit history.
Bottom line: you don’t need a perfect FICO to qualify for a mortgage, or even get a fair rate. But you do need to be looking for a home you can truly afford based on your income.
While you may qualify for a bigger, better house than you thought, it doesn’t mean you’ll be able to afford your current lifestyle with that bigger payment.