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Your credit scores and credit history play a major role in your ability to buy a home, finance a new car, or make other big purchases, but many times they’re forgotten about until it’s too late. As a mortgage broker, we’ve seen some great individuals miss out on their dream home because of unexpected credit issues. Becoming more familiar with how your credit scores affect home loans and interest rates will help you avoid pitfalls along the way to buying your new home.
What are Credit Scores?
Credit scores are a three digit number that range from 300 to 850. The higher your scores are, the better. Technically speaking credit scores are a representation of the likelihood that you’ll become delinquent on your credit obligations in the near future, based on the way you’ve handled debts in the past. In simpler terms, your credit scores tell others, like a mortgage broker, the probability that you’ll make payments on the money they lend you, based on how you’ve handled past debts. You can increase your scores, and the likelihood that others will lend you money, by making full, on time payments for the accounts you’ve already got open.
What Makes up My Credit Scores?
Your credit scores are calculated using multiple pieces of information in your credit history. Those pieces of information are grouped into the five categories shown below. The percentage next to each category shows its weight, or importance, in determining your credit scores.
1. Payment History (35%): Your payment history includes information such as delinquencies, public records, and whether you’ve made payments on time or not.
2. Credit Utilization (30%): Credit utilization isn’t just how much you owe on all of your credit lines. It’s a percentage of how much credit you owe compared to the total amount of credit available to you. For example, if your credit limits total $10,000 and you’ve used $5,500, then your credit utilization is 55%.
3. Length of Credit History (15%): Length of credit history looks at how long your accounts have been open and the last time activity was reported.
4. New Credit (10%): This includes any recent inquiries into your credit and the number of accounts you’ve opened recently.
5. Types of Credit or Credit Mix (10%): There are different kinds of credit accounts like installment and revolving accounts. Credit mix looks at which types of accounts you currently have.
What Credit Scores do I Need to Get a Home Loan?
There are a lot of different mortgage programs available and each one has different credit score requirements. The table below shows the minimum credit scores allowed for the 4 most popular home loan programs; but keep in mind that some mortgage lenders will enforce higher credit requirements than what’s shown in this table.
As you can see, it’s definitely possible to qualify for a mortgage with low credit scores, but it can come with a little extra work. When your credit scores are below 580, you may have to bring additional documentation, attend educational courses, or provide a larger down payment as part of the home loan process. With that being said, you still have options! At Wasatch Mortgage we’ve helped numerous customers with bad credit scores qualify for a mortgage.
What are Good Credit Scores for a Mortgage?
When you’re trying to qualify for a mortgage, credit scores of 680 or above are good. They’ll help you receive some of the best interest rates on government mortgages and conventional home loans. You’ll also have access to different mortgage programs. Some programs, like those with lender paid mortgage insurance, are only offered to borrowers with higher credit scores. With credit scores of 680, you’ll have a better chance of qualifying for these exclusive mortgage programs.
How do Credit Scores Affect My Mortgage Interest Rate?
Your credit scores have a big impact on the interest rate you get when you apply for a home loan. Mortgage lenders will reward you with the best available interest rates if you have high credit scores. That means you’ll save money by paying less interest over the life of your home loan. When your credit scores aren’t the best, you could end up with a higher interest rate and more expensive mortgage payments.
The extent to which your credit scores affect your interest rate also depends on the type of mortgage you choose:
1. Government Mortgages
On government mortgages, like FHA, VA, and USDA home loans, you’ll usually see a positive change in your interest rate for every 40 points you increase your credit scores.* That means you’ll receive a more favorable interest rate with a credit score of 720 than you would with a 680 credit score.
2. Conventional Mortgages
Conventional home loans focus on a single credit score, 680. When your credit scores are at or above 680, you’ll receive the better interest rate. When your scores are below 680, you’ll be offered an interest rate that’s not quite as good.*
It’s worth noting that your credit scores play a big role in determining the cost of your mortgage insurance premium for a conventional mortgage. Premiums can be expensive and improving your credit can quickly save you money. For every 20 points you increase your credit scores, you could reduce your monthly mortgage insurance premium.**
How can I Improve My Credit Scores?
There are a lot of ways to improve your credit, but here are a few simple ideas that can make a positive impact on your scores. These suggestions could help you save a lot of money by qualifying for a mortgage with a better interest rate.
1. Pay Down Your Debts
Your credit scores are significantly affected by the credit utilization that we mentioned earlier. Major credit bureaus want to see your credit utilization at or below 30%, meaning you haven’t used more than 30% of the credit available to you. Paying down your credit cards and other debts to get below 30% utilization could quickly increase your credit scores.
2. Pay off Late Payments and Collections
Sometimes late payments just happen. If your credit report shows any late payments or collections, it’s best to get those settled. One way to take care of a late payment or collection is to write a letter to the creditor requesting they remove it from your credit report. You should offer to pay off the debt in exchange for them removing it. Just make sure you get a written agreement from the creditor before you make a payment.
3. Be Consistent
Change isn’t always the best idea when it comes to your credit. When you make changes to your credit by closing an existing account or opening a few new accounts, it can cause your scores to drop. One of the best things you can do to improve your credit scores is to be consistent. Make your current payments on time, only open new accounts when necessary, and avoid making drastic changes, like increasing a credit limit.
How can I view My Credit Scores Now?
There are a few ways for you to see your credit scores. You can check them on one of the many websites that offer a free annual credit report or you can visit with a local loan officer. Be aware that online credit reports are oftentimes less accurate than the one you’d receive from a loan officer, plus a loan officer can help you create a personalized plan to improve your credit scores and get you ready to buy a home.
*Example based on a $200,000 purchase price with $250 in other monthly debts.
**Once your credit scores are 760 or higher, you’ll no longer be able to lower your mortgage insurance premiums by increasing your credit scores.