How Your Credit Score Affects Mortgage Interest Rates

The fact that you are seeking a loan for a new home may cause a lot of anxiety. After all it's a big purchase, and the monthly mortgage payments are of great concern. You want to be able to keep them as low as possible. Although you're aware that not every mortgage carries the same interest rate you aren't really sure why. There may be many causes. One is the fact that your credit score affects mortgage interest rates.

How a Loan Works

When you want to borrow money for a home loan you approach a lender and request a sum of money to be used to buy the home. Because you most likely don't have enough cash on hand to buy the home outright, you need an additional amount of money to help purchase the home. The lender supplies this money and the home becomes yours...sort of. As a result of you having to borrow the money the lender maintains an interest in the home. You agree to repay the lender the amount of money you borrowed over a predetermined period of time. Due to the fact that a lender makes their money by allowing you to use their money, the amount you pay back carries a financial penalty--it's called interest. That's how the system has worked since one person first borrowed something from another.

All Interest Rates Aren't Created Equal

The fact that a lender is willing to allow someone else to use their money doesn't mean they treat everyone equally. Some people are just naturally considered a better risk than others. If a lender determines you are a good risk, meaning they believe you will pay back the loan in a timely manner, they will offer you a low interest rate. However, if you are considered a bad risk, meaning the lender has some reasonable doubts as to your willingness or ability to repay the loan on time, they may still be willing to lend you the money, but will require a higher return on their money.

High Credit Score Value

In order to determine whether or not a potential borrower is a good risk or a bad risk, or lies somewhere in between, a lender must have some sort of guidelines to go by. One of the best sources of information for a lender in this determination is access to your credit history. The way the system works is that when a person establishes credit, especially if it's with a key lending institution, that lender will report whether or not you make your payments on time to a credit reporting agency. The credit reporting agency receives and compiles information from a variety of sources on your credit history. In turn, when you approach another lender for a loan, that lender will request your credit history from the credit reporting agency. Their evaluation of your loan application will be partly or mostly based on this information, so you will most likely be either accepted or rejected because of your credit history. There are three major credit reporting agencies in the U.S. They are Equifax, Experian, and TransUnion. In order to simplify the process a number system has been worked out, which is called your credit score. The higher your credit score is, the better chance you have of getting a loan, at least a low-interest loan.

Down Payment Counts

When you take out a loan for a home you're generally required to make a down payment. This will help convince a lender that you're serious about the purchase because you will have your own money tied up in the home. The more money you are able to put down the less money you'll have to borrow, and consequently the lower your mortgage payments will be. If your credit score is high the amount a lender may require you to come up with for a down payment will usually not have to be overly high, because you'd be considered a good risk. However, if your credit score is low, a lender may call for you to come up with more money for a down payment. This will lower your monthly payments and help convince the lender to provide you with the loan, although your interest rates will more than likely remain at a higher rate. Basically the higher your credit score is the better your chances of getting a low-interest loan even though you don't have a huge amount of money for a down payment.

To learn more about how your credit score may affect your chances of getting a mortgage or a good interest rate, check out this credit score guide.

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