When you apply for an FHA mortgage, lenders look at a variety of factors when they choose your interest rate. Contrary to popular belief, not all FHA borrowers get the same interest rate. It’s based on individual factors, of which your credit score is one of the top contenders.
Lenders work on what’s called risk-based pricing. They look at your risk of default and determine your interest rate from that. If you are a high risk of default, meaning you may default on your loan in the near future, the lender may offer you a higher interest rate than they’d offer a borrower with a low risk of default.
What Credit Score do You Need?
So what credit score do you need to get the best interest rate available? It depends on the lender. Some lenders want credit scores in the 700 range before they will offer their ‘best’ interest rate. Others are good with credit scores in the mid-600s. It really varies by lender.
So what credit score do you need? You need the best credit score that you can muster up before you apply for the FHA loan. We recommend looking at your credit report at least 12 months before you apply for a mortgage. This way you can see what negative credit history you have going. If there’s a lot, you have some work ahead of you. If you have all positive credit history, keep up the good work and you should be able to enjoy a low FHA interest rate.
Your Credit Score Isn’t the Only Factor
Luckily, your credit score isn’t the only thing lenders look at when determining your FHA interest rate. They look at the big picture. They want to know what type of risk you bring to the table. A high credit score is good, but if you have a high LTV and high debt ratio to bring along too, your ‘good risk’ just turned into a ‘mediocre risk.’
In a perfect world, you’d have a low LTV (make a large down payment), have a low debt ratio, and a high credit score. Don’t worry, though, this doesn’t happen often. You may have one but not the other or you may even meet a few of those requirements, but not all of them.
Lenders will look at all of your factors collectively to decide if you are a good risk or not when they determine your interest rate.
How to Increase Your Credit Score
If you know that your credit score is on the lower end, and for FHA loans this means around 580, you may want to see what you can do to boost it up. Even though the FHA allows lenders to write loans for borrowers with a credit score as low as 580, it doesn’t mean you’ll get a great interest rate. Instead, you should try boosting your score with one of the following tips:
- Bring all credit accounts current
- Pay your credit card balances down to less than 30% of the total limit
- Don’t open any new credit cards, car loans, or personal loans
- Don’t close any credit cards that you don’t use
If you do these things and continue to consistently pay your bills on time, your credit score should eventually increase, giving you a chance at a better interest rate.
Even though your credit score isn’t the only factor that affects your interest rate, it is one of them. See what you can do about maximizing your credit score so that you can get the low-interest rate you desire. Of course, it’s even better if you have a low debt ratio and you make a large down payment on your home.