Why Is Good Credit So Important for Homebuyers?

You probably know that your credit scores can impact your ability to get a mortgage, but that’s not all. Your scores can affect several home-related costs, as well as your future financial options.

How Do Credit Scores Influence Mortgages?

When a lender evaluates your application, it wants to figure out how risky it would be to give you a loan. A high credit score shows that you have a history of making payments on time and managing debt responsibly. A low credit score, on the other hand, can signal to a lender that you would be more likely to default on a mortgage.

Interest Rates

If you have bad credit, you might only qualify for a loan with a high interest rate. That can lead to high monthly payments and chronic financial stress. You’ll also pay more in interest (possibly tens of thousands of dollars more) over the life of the loan.

Down Payments

From a lender’s perspective, a substantial down payment makes you less risky. If you can’t afford to make a large down payment, but you have good credit, you’ll probably still be able to get a loan.

If you have bad credit, a lender can require you to make a large down payment. If you can’t afford to do that, you might have to spend years saving more money and improving your credit before you can qualify for a mortgage.

How Do Credit Scores Affect Insurance Costs?

Homebuyers tend to focus on the price of a home and give less thought to other expenses. If you own a house, you’ll need one or more types of insurance.

Homeowners Insurance

If you get a mortgage, you’ll have to take out a homeowners insurance policy. Even if you’re not required to have homeowners insurance, you should. It will help you avoid large out-of-pocket costs if your house gets damaged by a storm or another type of covered event.

In most states, homeowners insurance companies use credit-based insurance scores to assess risk and set premiums. Customers with higher scores generally pay lower rates.

Mortgage Insurance

A conventional lender will require you to buy private mortgage insurance if you put down less than 20% of the purchase price. The purpose of PMI is to protect the lender if you default on your mortgage, but you’ll have to pay the premiums. The cost of PMI is based in part on your credit score. A higher score can translate to lower premiums.

You’ll have to pay for mortgage insurance premiums if you take out a loan through the Federal Housing Administration. Credit scores also influence the cost of mortgage insurance premiums.

One key difference between PMI and MIP is how long they last. You’ll be able to eliminate PMI when you have 20% equity. You’ll have to pay for MIP for 11 years if you make a down payment of at least 10% on an FHA loan. If you put down a smaller amount, you’ll have to keep MIP until you pay off the mortgage, refinance, or sell the house. If you have high premiums because of bad credit, those costs can strain your monthly budget, and they can really add up over time.

How Can Your Credit Scores Affect Your Financial Options Later?

Your circumstances and goals will probably change in the future. You might want to use equity to cover expenses or refinance your mortgage to save money. Your credit scores will come into play in those situations.

Home Equity

Equity can be used for a variety of purposes. Homeowners typically use equity to cover the cost of renovations or pay off high-interest credit card debt.

If you take out a home equity loan, you’ll get a lump sum. With a home equity line of credit (HELOC), you’ll have access to funds that you can use as needed.

With either option, you’ll have to make monthly payments with interest. Your interest rate will depend on your credit score. A low score can lead to a high interest rate, which will make it expensive to use the equity you’ve worked hard to build up.

Refinancing

If mortgage rates fall in the future, you might want to refinance your loan to lock in a lower rate and reduce your monthly payments. Borrowers qualify for different interest rates based on their creditworthiness. Good credit can help you secure a low interest rate.

How Can You Improve Your Credit?

As you see, having strong credit can make it easier to buy a house and save you money in the long run. If your credit scores aren’t where you would like them to be, you can improve your situation by consistently paying your bills on time and reducing your credit card balances. Paying down debt will lower your credit utilization ratio and debt-to-income ratio, which will strengthen your credit.

What Else Should You Do to Get Ready to Buy a House?

Understanding the role of credit is important, but there’s a lot more that you need to know before you buy a house, including how to choose a real estate agent, how to find a house that’s right for your family, and how to select the right kind of mortgage.

You can learn about all of that in Financial Freedom Voyage’s First-Time Homebuyer Masterclass. It explains the process in detail, highlights ways that buyers get into trouble, and clears up common misconceptions.

When you finish the course, you’ll receive a certificate of completion that you can share with your mortgage lender, housing counseling agency, or down payment assistance program. Enroll now.

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