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As a nation, we obsess over credit scores. Once hidden in the computer terminals of banks, they’re now available for free to you via many providers on the internet. But in reality, getting a loan takes into account much more than just your credit 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 2014 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 No. 1 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%
Clearly, your debt-to-income ratio is key.
Why is debt to income a bigger factor than your score?
It is crucial that a borrower be 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 ratio below 36% when counting all of your monthly debt obligations, including credit cards, car loans, student loans and housing expenses.
Officially, conforming loans can be secured with debt-to-income ratios as high as 45% or so, but that’s cutting it close, unless you have substantial savings or bonuses that don’t get counted in the income calculation. Ideally, you shouldn’t be going any higher than approximately 35%.
Think about it this way: If you’re pulling in $5,000 a month before taxes, a 45% 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 each month for other expenses.
Yes, you may get a tax benefit at the end of the year for deducting interest, if you itemize, but the reality is you’re pretty house poor in this situation, even if you have a perfect credit score.
At a 35% 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% ratio.
Will a better score help at all?
Your credit score can definitely help when it comes to getting a better mortgage rate.
Here is a national sample of 30-year fixed mortgage rates on a $300,000 loan by FICO score as of May 29, 2019 (these numbers will change frequently, but this should give you a general idea of how your score might affect your rate):
- 760- 850: 3.701% $1,381 / month
- 700-759: 3.923% $1,419 / month
- 680-699: 4.100% $1,450 / month
- 660-679: 4.314% $1,487 / month
- 640-659: 4.744% $1,564 / month
- 620-639: 5.290% $1,664 / month
The difference between a marginally excellent credit score (700-759) and a truly excellent one (760+) is about $38 a month on a $400,000 mortgage. That’s around $494 a year, and $14,820 over the life of the mortgage.
Don’t take on new credit
One thing you should understand if you’re in the market for a mortgage is that you should be careful about applying for new credit.
Loan officers don’t want to see a lot of recent credit applications, and each one can temporarily ding your FICO 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 six months before getting a mortgage. Otherwise a couple of cards could end up ultimately costing you in extra payments.
And if you have a borderline score, pay as much debt off as you can before applying. This will help your debt-to-income ratio, and improve your score. Just make sure you do it at least one month before applying for the mortgage, 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 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 count as one inquiry on your credit report.
Need help figuring out which lender to go with? LendingTree, MagnifyMoney’s parent company, has a handy mortgage shopping tool. You may be matched with lenders who want to lend to someone with your score and income. You can start the mortgage comparison process by visiting LendingTree’s website:
you don’t need a perfect FICO score to qualify for a mortgage, or even to 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 you would, it doesn’t mean you’ll be able to afford your current lifestyle with that bigger payment.