Getting an interest rate to purchase a home is similar to when you were back in school earning good grades – or not. The teacher put together many components from your test scores from your research papers to come up with the percentage rate you would receive on your report card.
That’s exactly what lenders do to determine a mortgage interest rate. They look at a variety of things to determine if they will trust you with their money and whether or not you are a good risk when it comes to paying the money back in a timely manner. But remember to shop around because you could get a better mortgage rate from someone else. That better rate could save you thousands of dollars each year or through the lifetime of the loan.
“Most of the credit decisions of approval are based on underwriting software,” says Ron Haddad, vice president of residential mortgage lending at Key Mortgage Services, Inc., Chicago. “It’s all based on risk assessment. The higher the risk you are, the higher the interest rate.”
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If you are a risky borrower in the eyes of a prospective lender, then you will most likely see much higher interest rates or have to put more in the down payment then what advertised rates state.
For instance, you can get the best interest rate if you meet the criteria on the underwriting software – meaning you have a very high credit score of over 740, your credit history is pristine with no late payments and no collections, and you haven’t used to too much credit. Plus, you have to have the right income, a good down payment and the right type of home you are going to purchase. All those details matter in the world of mortgage rates.
But Haddad says that after more than a decade in the lending business that nothing surprises him anymore. He has seen people with bankruptcies with 700 credit scores get good loans. And then he’s seen people who have never made a late payment with only a 640 credit score and not get a good interest rate.
“A loan officer has to work with the credit report to determine more than what the credit score says. We can help people and work with the information we get in the report,” he says.
For instance, not only does your credit report count when it comes to what interest rate you get but it also matters what kind of home you are buying.
“Condominiums carry a higher risk for lenders than a single family home with a backyard,” Haddad says. “A $300,000 condo with 20 percent down will have a higher rate of interest than a single home for $300,000 with 20 percent down. There’s just an additional level of risk for condos. You might have to put 25 percent down on a condo to get the same rate you would for a single home.”
Lenders have been going by a risk-based pricing practice for a while. That means they offer better deals to people who are a much less risk of not paying back the loan, says VantageScore Solutions, LLC., the company behind VantageScore credit scoring model.
The website states that lenders feel more comfortable giving out large amounts of money to those with high credit scores. That just makes sense.
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About 50 million individuals – which is 25 percent of all individuals with credit scores — have scores greater than 785, according to research by myFICO, a subsidiary of FICO (an analytics software company and owner of the FICO Score created by America’s three credit reporting companies of Equifax, Experian, and TransUnion.)
These high credit achievers use on average only 7 percent of their available revolving credit, and average four credit cards or loans with balances. Revolving credit can include credit cards such as a MasterCard or a retail store card such as Target’s. These are the people that get the really good interest rates.
But sometimes things happen and you might get thrown into the high risk category of credit scores without you even knowing it.
“It could be a $50 medical co-pay from five years ago that nobody reached out to you to pay, and it went into collections,” Haddad says. “It could be anything like that that could dump your credit score much lower.”
He says to just be aware of your credit report and check it every year to see that everything is correct.
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And then sometimes, by just having a lender who is willing to go that extra mile to help you get a loan at a good rate, miracles can happen. For instance, Haddad just helped a guy secure a mortgage even though he had some dents in his financial background.
“He had nine jobs in the last two years and a bankruptcy four years ago. We were successful in getting him money from the Welcome Home Illinois down payment assistance program and an interest rate of 3.75 percent for an FHA loan. That was a below market interest rate,” Haddad says
The borrower had to write multiple letters to the lender explaining the situation he was in and why he was in it. It worked.
“Sometimes, you just have to dig a little deeper and work a little harder to get someone a loan at a good interest rate,” he says.