Cover story: Credit score central to loan OK, rate

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Since 2007, Fannie Mae and Freddie Mac, and therefore most lenders, have offered consumers tiered mortgage rates based on their credit score. In recent years, most lenders will charge a slightly higher interest rate for borrowers with a credit score under 740. The size of the increase depends on the credit score, so there are tiered interest rates for borrowers for each 10- to 20-point change in score. For example, a borrower with a credit score of 740 could pay 4.59 percent interest, while a borrower with a credit score of 640 would be required to pay 5.41 percent, according to www.myfico.com.

Fannie Mae and Freddie Mac announced additional fees for mortgage borrowers at the end of 2010, including some tied to credit scores and others related to the type of property being purchased. Many lenders recently implemented these changes in their loan programs.

“Consumers with a credit score under 740 will be charged an additional quarter point at the closing or they can opt to pay the fee in an interest-rate increase of one-eighth percent over what they would otherwise pay,” Mr. Busch says.

“Loan prices will also go up for people who want to refinance if they have a home-equity loan that they want to keep,” he says. “The biggest impact will be felt by people with scores under 700 with less than 20 percent equity when refinancing, or who make a down payment of less than 20 percent, because they will have to pay a half-point at closing or see their interest rate go up by quarter percent.”

One point is equivalent to 1 percent of the loan amount, so borrowers who must pay a half point on a $400,000 mortgage would pay $2,000 at the closing.

Mr. Busch says consumers have the choice of paying the fee at the settlement or opting for the increased interest rate.

“Another change is that while buyers making a 25 percent down payment (or with 25 percent equity when refinancing) and decent credit were not charged anything extra in the past, the threshold is now 30 percent,” Mr. Busch says. “If you make a down payment of less than 30 percent, the loan costs will be one-eighth percent higher in interest or a quarter point at settlement.

“Basically Fannie Mae and Freddie Mac are increasing interest rates on everyone without 30 to 40 percent equity and stellar credit. Even people with a great credit score will have to pay more if they don’t have a lot of equity.”

The best scenario for consumers is to raise their credit score as much as possible by paying off debt and paying all bills on time. New rules that went into effect Jan. 1 require lenders to provide all consumers with a disclosure that explains why they are qualified at a particular interest rate.

“For people with a low credit score, this disclosure letter can be enlightening, but for the most part, a lender will have already discussed any credit issues with the borrower at the time of a loan application,” Mr. Thomas says.

Credit scores are renewed once per month, but improvements to a score, depending on the reason for a lower score, can take months to appear, or even years in the case of a judgment or bankruptcy. Borrowers who cannot wait for an improved credit score likely will have to pay a higher interest rate and possibly more in fees at settlement to qualify for a mortgage. Depending on the score, some borrowers will not qualify at all.

“If a consumer does not improve their credit score before applying for a loan, they will have to pay a higher price to borrow money,” Ms. Sheehan says. “This is true whether it is a credit card, a car loan or a mortgage. They are a higher risk and lenders will only lend if they can cover this potential risk.”

Mr. Thomas says borrowers sometimes can qualify for a loan if they have additional cash and can make a down payment of 40 percent or more.

“Most lenders have a category of loans for people who will make a bigger down payment, but even so, they may have to pay a higher interest rate because of their credit history,” Mr. Thomas says.

Ms. Sheehan agrees that the extra down payment will not change the higher price borrowers must pay if the buyer has a low credit score.

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