by M. Shayne Arcilla
A FICO score of at least 760 will get you the most favorable rates on a mortgage.
Types of Home Loans
The two most common types of mortgage loans are the adjustable- and fixed-rate mortgages. A fixed-rate mortgage provides certainty in regards to monthly payment amounts since there is only one interest rate for the life of the loan. The disadvantage is that the borrower may be paying more in interest during a low-interest rate environment. On the other hand, an adjustable-rate mortgage, or ARM, provides variable interest rates throughout the term of the loan. The most common ARMs are those offered with a three-, five- or seven-year fixed-rate period, after which the interest rate becomes a floating rate. Another type of mortgage offered is the balloon loan. Interest rates offered with a balloon loan may be as low as those offered with an ARM, but the life of the loan is shorter--seven or ten years--at the end of which the entire loan amount is due.
Qualifying for a Mortgage
To qualify for a mortgage, a borrower must submit documents showing proof of income, employment, credit history, a summary of his monthly expenses, assets and liabilities. Lenders want to see a reliable stream of income, stable employment, low monthly expenses relative to income, and no adverse credit event such as a foreclosure, bankruptcy or delinquent amounts. A general rule of thumb is to limit fixed housing expenses, such
as mortgage, utility bills and insurance, to approximately 28 percent of gross monthly income.
Credit Score Effects on Mortgage Rates
Bankrate.com has compiled a table that illustrates the effects of credit score on mortgage rates. To qualify for the lowest interest rate on a conventional 30-year loan, a potential borrower should have excellent credit, with a 760 or above credit rating. Those with scores between 660 and 759 can still qualify for a decent loan rate, but anything below will result in interest rates that are at least two percentage points higher than the most creditworthy tranche. Those with the worst credit scores can expect to pay at least four percentage points higher in interest.
Why Interest Rates Matter
A good credit score can help you save money. An excellent credit rating will qualify you for the most favorable terms and interest rates a lender can offer, while a poor credit rating can result in thousands of dollars more in interest payments. Take for example a borrower who has a credit rating of 760. With his score, he could acquire an interest rate of 5 percent on his $100,000 mortgage. Over the next 30 years, the borrower will accumulate over $95,000 in interest payments. Meanwhile, a borrower with a score of 550 may only acquire an interest rate of 9 percent on the same $100,000 mortgage. Over the life of the loan, he would accumulate over $192,000 in interest.
Preparing Your Credit Report