Most people have heard the term FICO score, but some remain confused as to what it actually is and if it affects them when they try to obtain a mortgage. A few questions can be answered to help people understand how it can affect the amount of interest you pay on your loan.
What is a FICO Score?
A FICO score is a credit grade of a borrower, based on credit history
as reported to 3 separate credit reporting agencies. It is based on a
number of factors, including the amount of credit a person has, payment
history, late payments, judgments, loan defaults and other factors.
A mathematical formula developed by Fair Isaac Corporation (thus the
term FICO) is used to grade the credit risk the borrower represents.
Scores range from 350 to 850. A score of 650 or better is considered
good and a score above 750 is considered very good.
Does a FICO Score Affect a Mortgage Rate?
Mortgage interest rates are calculated in part, on the amount of risk
the borrower represents. The higher the risk the borrower presents, the
higher the interest rate the lender must charge to account for the
risk. With FICO scores, the lower the score means a higher risk, and
thus, less favorable mortgage terms. Those with low FICO scores may have
difficulty finding a mortgage.
How much the rate will change depends on the lender. Myfico.com
estimates that with current rates, a borrower with an average FICO score
can expect to be charged more than 1.5 percentage points more than a
borrower with an excellent score. Though the difference in interest may
not seem to be much, it will add up over time.
For example, a borrower seeks a $200,000 mortgage on a 30 year fixed
rate. Because they have an excellent credit score, they obtain a
mortgage at 3.549%. Monthly principal and interest payments at that rate
amount to $904 per month. Total interest paid on the loan will be
$125,285 over the 30 year period.
Another borrower seeking the same mortgage has a lower credit score,
in the average range. The borrower is offered the same mortgage but at
5.138% interest. The monthly payment will be $1094 per month and the
borrower will pay $192,607 in interest. The difference in this case,
between an excellent FICO score and an average score is $187 per month,
$67,302 over the life of the mortgage.
Is a FICO Score Permanent?
No. A credit score will change depending on the borrower’s credit
history. A borrower with a lower score can increase it over time by
taking certain steps to improve it. Obtaining their credit report is the
first step to improvement. It should be reviewed for accuracy, and
incorrect entries should be reported. Outstanding judgments, if any,
should be paid. Paying down revolving credit card debt also can help.
Visiting an experienced mortgage professional to discuss his or her
current FICO score is another good start. The mortgage professional can
discuss the effect it has on your mortgage rates and how to improve your
score and put a borrower on the path to obtaining the best mortgage