How Does Good Credit Lower Mortgage Rates?

How much does your credit score impact mortgage rates? Economists at the National Association of Realtors have developed a chart which neatly illustrates the value of good credit -- and the real-world penalties for credit dings.

Many new mortgage rules have come into effect as a result of Wall Street reform. Among those rules are a series of standards designed to make lending less risky, in particular the creation of what are known as qualified mortgages or QMs. Most loans today are QMs for the simple reason that the definition of a "qualified mortgage" includes FHA, VA and conventional loans which can be bought by Fannie Mae and Freddie Mac.

The rules also allow lenders to make non-QM mortgages and there are cases where borrowers might want such financing. For example, a jumbo mortgage might be a non-QM loan simply because the amount borrowed is more than FHA, VA or conventional loan limits. Another form of financing outside the qualified mortgage definition would be an interest-only mortgage, a type of financing where the borrower pays only interest during the first few years of the mortgage. Because such loans are not qualifying mortgages, it might be expected that borrowers will pay higher mortgage rates for such loans. The question is: How much higher?

Mortgage Rates And Credit

Economists at NAR polled a number of lenders and raised an interesting question: How does credit impact mortgage rates for non-QM loans?

The NAR chart presents an interesting picture. It tells us that the stars of the marketplace, borrowers with credit scores of 720 and above, will see very little impact on their mortgage rates, perhaps 10 basis points in many cases. However, depending on the lender and the loan product, some borrowers -- even those with good credit -- could see a .5 percent rate bump. (A basis point is equal to 1/100th of a percent, so 25 basis points would represent a .25 percent different in an interest rate, say 4.3 percent versus 4.55 percent.)

Those in the middle rung, individuals with credit scores between 640 and 720, seem most likely to pay .5 percent to .75 percent more for non-QM financing according to the study.

Alas, those with poor credit, individuals with a credit score below 640, will likely pay 1.5 percent more with non-QM mortgages.

The chart is interesting but keep in mind some cautions:

First, many lenders will not offer non-QM loans because they do not want the hassle and liability such financing can represent.

Second, it may be that borrowers with solid credit will not see any rate increase at all. In fact, they may pay less than individuals who get qualified mortgages. As an example, the Mortgage Bankers Association reports that for the week ending March 7, 2014 that conventional loan borrowers typically had a 4.52 percent while jumbo borrowers -- the folks with non-QM financing -- were paying 4.41 percent.

Third, regardless of whether a loan is a qualified mortgage or not, all lenders must abide by the ability to repay requirements established under Dodd-Frank. The toxic loan products which arose between 2000 and 2006 are out.

The Bottom Line: Whether you finance with a qualified mortgage or a non-qualified loan product, you'll only get the best deals in town if you have a credit score above 720. This means it pays to review credit reports to get rid of any out-dated or incorrect items which may be dragging down your score.

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