Until a few years ago, credit scoring was primarily used to determine if you could be approved for a home loan. Except in subprime lending, your FICO score wasn’t commonly used to determine what rate you’d be offered. Today, more often than not, your credit score affects your mortgage rate. According to MyFICO.com, borrowers with the credit scores in the 620- 639 range are offered mortgage rates 1.59 percent higher than those with FICO scores of 760 or higher.
How credit scoring affects your mortgage rate, continued. Credit scoring affects mortgage rates in different ways, depending on the program you choose. Here are the details.
Fannie Mae and Freddie Mac
Fannie Mae and Freddie Mac implemented risk-based pricing back in 2008. Mortgage defaults were increasing, even for loans to the so-called “prime” borrowers with traditional “conforming mortgages” originated under Fannie or Freddie Mac guidelines. The government needed the mortgage giants to collect more fees to offset the losses. However, they didn’t want to raise the cost of borrowing for all borrowers; they only wanted the riskier borrowers to pay more. That brought risk-based pricing to mainstream mortgage lending.
Fannie Mae and Freddie Mac add surcharges to borrowers with lower credit scores, and these charges can increase with every 20-point decrease in credit score. There are eight tiers, ranging from < 620 to 740 or greater. Surcharges range from a .25 percent discount to a 3.25 percent add-on to the loan fees.
FHA, VA and USDA
Government mortgages do not use risk-based pricing. A VA mortgage to a veteran with a 600 credit score carries the same funding fee as one to a vet with a 700 FICO. FHA and USDA loans work the same way – whether the fee to the government is called a funding fee or an upfront mortgage insurance premium, it doesn’t vary by credit score. However, a low FICO can still cause you to pay more for a government loan.
Government loans come with minimum guidelines that applicants must meet to be approved, but lenders can apply tougher standards (called overlays) if they choose to – and many do. In fact, industry insiders estimate that between 80 and 95 percent of mortgage lenders impose more restrictive guidelines than the government agencies do, and that borrowers who have fewer lenders to choose from because of those overlays are likely to pay higher rates.
Jumbo, non-conforming and portfolio mortgages are not sold through Fannie Mae or Freddie Mac, nor are they backed by the government. They may be purchased by investors or kept in the portfolios of the lenders that make them. Consequently, each group of investors or lender is likely to make its own rules. Here’s a typical pricing adjustment from a jumbo lender:
- FICO > 800: reduce fees by .5 percent
- FICO 760 – 800: no adjustment
- FICO 720 – 759: Add .125 percent to fees
- FICO < 720: Add .5 percent to fees
The wild and wooly mashup of jumbo, non-conforming and portfolio mortgages means there is a lot more pricing variation across the board, and there is potentially more to be gained by shopping aggressively for lower mortgage rates in this category.