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Why Are Credit Scores Important?

Credit scores are used by most lenders to evaluate risk.  Interest rates on loans include a rate of return for the lender based on risk.  The higher your credit score the lower the risk for the lender so people with high scores are offered lower interest rates and other reduced fees like closing costs on a mortgage.   Your score could impact the cost of all debts not just mortgages.  Car loans, credit cards and loans from your bank or credit union could all add up to a significant amount of increased expense.

But I am an expert only in the realm of mortgages.  There are three points that are dictated by the FICO Score.  The first two are in the expense of borrowing money.  As already stated the interest rate is lower for a high score, or stated another way they are much higher if the score is low.  This can quickly add up to a very large pile of money on a conventional loan.

The chart below shows Fannie Mae’s pricing tier.  The left side of the chart shows the FICO Score, the top line shows the loan-to-value.  Loan-to-value is also a risk factor, the larger the down payment the lower the risk.

Fico LTV Adjustments Why Are Credit Scores Important?

Notice the rest of the numbers on the chart range from +0.250 to -3.250.  These are the adjustments made either to the cost or interest rate of the loan. There are a couple of ways to adjust the interest rate, by raising or lowering the rate or increasing or decreasing the closing cost or combination of the two.

Everyone has heard of points. This is one of the places where they come from. On the above chart if the borrower has a credit score of 640 and makes a 15% down payment the points would be 3.25% of the loan amount.  On a mortgage amount of $200,000 that amount of points adds $6,500 to the closing cost!

In the Louisville market area this hit to closing cost would make the closing cost and pre-paids total around $11,000 or more. Most buyers would have a problem with that total.

The other way to absorb this adjustment is to increase the interest rate.  This size hit in rate would be an increase of half a point up to three quarters.  On the same $200,000 loan amount, if the borrower elected a rate increase instead of paying points the amount of additional interest on a 30 year loan would be in the range of $30,000.

Another factor is called Minimum Threshold. All lenders have a couple of minimum thresholds regarding credit scores.  In my shop the minimum credit score is 640 for most of the loans we offer.  I cannot approve a mortgage if your middle score is 639.  A one point difference not only impacts the cost it can also be the difference between being approved or declined.

A good Credit Score is very important!


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