In this guide, we will cover the benefits of credit score improvement in mortgage process. Credit scores are the biggest determinant of what mortgage rates borrowers get, especially on conventional loans. The most important factor that determines pricing of mortgage rates on government-backed loans (FHA, VA, USDA Loans) are credit scores. The higher your credit scores, the lower your mortgage rate.
On FHA, VA, and USDA loans, if credit scores are under 620, interest rates will definitely be higher. Lenders view borrowers with lower credit scores as higher risk borrowers. The higher the risk, the better the rewards. Therefore, lower credit score borrowers (considered higher risk) get priced with higher rates (considered higher rewards).
How Are Mortgage Rates On Government-Backed Loans Priced
Loan Level Pricing Adjustments (LLPA), commonly referred to as pricing hits, are pricing adjustments on rates due to layered risks. All rates start at a par rate. Par rate can be 3.5%. Then, each individual borrower can get pricing hits, or LLPAs on things lenders considered layered risks. Examples of loan-level pricing adjustments are credit scores, loan-to-value, geographical area, debt-to-income ratio, type of property, automated vs manual underwriting, and type of occupancy.
LLPA for borrowers with credit scores lower than 620 credit scores can be as high as 1.0% than borrowers with credit scores higher than 620,
To get the best available mortgage rate on government-backed loans, borrowers need a credit score of 640 or higher. There are no loan-level pricing adjustments for loan-to-value, type of occupancy (you can only be an owner-occupant primary homeowner on government loans), and debt-to-income ratio.
How Are Mortgage Rates On Conventional Loans Priced
To qualify for a conventional mortgage loan, borrowers need a minimum credit score of 620. Conventional loans are extremely sensitive to credit scores than government loans. There is no government guarantee on conventional loans so loan-to-value matters on pricing on mortgage rates.
A 620 credit score is considered a very low score for a conventional loan. Pricing on mortgage rates is different on government-backed loans versus conventional loans.
Loan to value does not matter when pricing mortgage rates on goverment-backed loans due to the government guarantee. The reason why loan-to-value does not matter on FHA, VA, and USDA loans is due to the government guarantee. Factors that impact mortgage rates on conventional loans are credit scores, loan-to-value, purchase or refinance or cash-out refinance, type of property, occupancy type (primary home, second home, or investment property), and debt-to-income ratios.
Case Scenario On Loan-Level Pricing Adjustments
We Will Use A Case Scenario With illustrative Hypothetical Sample Rates:
- Chances are borrowers will get quoted with a mortgage rate of 5.0% or higher
- The mortgage rate will get lower for every 20 score improvement
- For example, with a credit score of 620, the mortgage rate will be priced at 5.5%
- If the credit score were 640, let’s assume pricing is at a mortgage rate of 5.25%
- For a credit score of 660 mortgage rate will be 5.0%
- Borrowers with credit scores higher than 680 pricing would be 4.75%
- 700 score will improve conventional mortgage rate to 4.5%
- A 720 credit score will yield a 4.25% mortgage rate
- A 740 plus score yields the best available conventional mortgage rate of 4.0% on a 30-year term
The above is a case scenario on the importance of credit scores and mortgage rates. We used fictitious sample rates for illustrative purposes. The higher the credit scores, the less of a risk factor borrowers are under the views of the mortgage lender. Higher credit score mortgage loan borrowers are rewarded with lower mortgage rates.
Fluctuations Of Credit Score Improvement In Mortgage Process
Credit scores do fluctuate every month. Consumers have higher credit card balances one month, then credit scores will be lower than a month where credit card balances are lower.
The credit scores that will be used throughout the mortgage approval process will be from the credit report that will be pulled at the time borrowers sign the mortgage application.
Consumers should make sure that credit scores are at the highest potential prior to starting the mortgage approval process. Credit Score Improvement In Mortgage Process can benefit borrowers. The higher credit scores can be used for pricing and locking the mortgage rates.
Credit Score Improvement In Mortgage Process Will Dictate Mortgage Rates
As mentioned earlier, when you decide to start the mortgage approval process, the mortgage loan originator will pull a tri merger credit report.
A tri merger credit report is a credit report from the three giant credit reporting agencies:
- Transunion
- Experian
- Equifax
Borrowers have three credit scores:
- one credit score from each of the three credit bureaus
- The mortgage company will use the middle of the three credit scores
For example
- Transunion credit score is 600
- Experian credit score is 650
- Equifax credit score is 700
How Lenders Determine The Qualifying Credit Score Used During The Mortgage Process
The mortgage lender will use the 650 middle credit score from Experian to qualify. The 650 credit score will be used throughout the mortgage approval process until the closing of a mortgage loan. In the event, if the mortgage loan approval process goes beyond 120 days, a new credit report will need to be pulled and the new credit score will be used. The 650 credit score will be used to determine the mortgage rate borrowers qualify for.
Some lenders like Gustan Cho Associates can use the newer Credit Score Improvement In Mortgage Process to price out the mortgage rates prior to locking the loan.
The higher the credit score, the lower the mortgage rate. In the event, if there is credit score improvement in the mortgage process. If credit scores drop during the mortgage approval process, borrowers are in luck because the mortgage lender needs to still go off the 650 credit score in qualifying and approving a mortgage loan.
What If Credit Scores Increases?
Credit scores fluctuate month to month. The credit score that will determine the mortgage rate category will be the credit score initially pulled at the time of mortgage application and disclosures. There are times where credit scores will significantly improve during the mortgage approval process. The newer higher credit scores can qualify for a lower rate. Unfortunately, most lenders do not let you do a bait and switch in the event if credit scores have significantly improved in the middle of the mortgage approval process.
For example, if the mortgage rate was locked at 5.625% due to credit scores being at a 580:
- credit scores have improved to 623.
- 623 credit score will qualify for a 3.75% mortgage rate.
- This is a huge decrease and may save borrowers a lot of money.
- But unless borrowers change to a different wholesale mortgage lender, the 580 credit score will be the credit score used to price the rate.
Disclaimer: The above rates used are not current rates but rather hypothetical rates used to illustrate this case scenario.
It is extremely important that before a home buyer starts the mortgage approval process that they have their credit scores maximized. Gustan Cho Associates will allow the new Credit Score Improvement In Mortgage Process to be used in locking rates.
Changing Lenders To Get A Better Mortgage Rate If Credit Scores Goes Up
There are cases where borrowers change mortgage lenders in order to get a lower rate due to credit score improvement during mortgage process. The best way to explain this is in a case scenario.
- If credit scores is between 580 and 619, borrowers will still qualify for a 3.5% down payment FHA loan.
- However, the maximum debt to income ratio generally get an approve/eligible per AUS is 31% front-end and 43% back-end.
- If credit scores are over 620, then automated underwriting system generally renders an approve/eligible per AUS with a front-end 46.9% and back end of 56.9% debt-to-income ratio.
Case Scenario Of Getting An FHA Loan Approval
- One of my clients get approved for a mortgage loan with a credit score of 597.
- Her debt to income ratio was 42.5%.
- Since her credit scores are under 620, the particular wholesale investor had pricing of 5.5% rate.
- We were set to close.
- Our closer was preparing the HUD but a last-minute hiccup happened.
- Her initial homeowner’s insurance quote was wrong.
- With her new homeowners’ insurance quote, her debt to income ratios exceeded 43% debt-to-income ratios.
- As mentioned earlier, if the borrower’s credit scores are higher than 620, the AUS will render and approve/eligible with a 46,9% front-end and 56.9% back-end.
- If borrowers credit scores are under 620 (between 500 and 620), borrowers generally will get an approve/eligible per Fannie Mae’s Automated Underwriting System
- with a 31% front-end and 43% back-end debt-to-income ratio.
- We needed to lower the debt-to-income ratio threshold under the 43% DTI mark.
- I tried everything including trying to buy down the rate.
- Buying down the rate was way too expensive.
- The borrower did not have enough funds to buy down the rate with discount points.
- I re-ran her credit and her credit scores went up dramatically to a 623.
- The existing wholesale lender could not replace the 597 credit score used at the time of the loan application with the new credit score.
- So what we ended up doing was canceling the file with the existing wholesale lender and taking it to a different wholesale lender with her new 623 credit score.
- Since it was an FHA loan, the appraisal transfer was not a problem.
- Since my processor had almost a clear to close from the previous wholesale lender, she had all the documents in order.
- The borrower needed to sign a new loan estimate and disclosure package from the new wholesale mortgage lender.
- Once we got the signed documents, the processor processed the file and submitted to underwriting of the new wholesale lender.
- Loan got conditional approval, processor cleared all conditions with borrower, locked the loan with a 623 FICO priced at 4.25% and submitted back to underwriter for a clear-to-close.
- Got clear-to-close and closed loan at 4.25% rate.
- Timeline was two weeks from submission to closing with second wholesale mortgage lender.
The above case scenario is an actual case scenario. There are some wholesale lenders that do not accept a recent second hand file (file that has been denied or pulled by a wholesale lender) without a good reason and explanation. On the above case scenario, the borrower could not qualify for the loan with the first wholesale lender due to exceeding the debt-to-income ratio allowed due to higher pricer on the rate because of the intial 597 FICO. The wholesale lender would not allow the borrower’s updated credit score in pricing the rate. Some lenders only allow pricing mortgage rates with only the initial credit score used to qualify the borrower. The lender will not allow using the increased credit score during the mortgage process,
