When buying a home, there are several options to consider when it comes to financing the purchase of your home. Each option has their pros and cons that should be weighed in light of your specific situation. By far, the greatest percentage of home purchases are financed with either FHA, VA, or conventional loans. Each of these loans has limits; for FHA, the limits vary by county. Conventional loan limits are set at a national level but some high cost areas have higher limits. For people who are purchasing more expensive homes, there are jumbo loans that that will finance amounts beyond the limits of the three loan types mentioned above. There are also some programs that will finance people who don’t quite fit into the boxes of FHA, VA, or conventional loans but still are good credit risks. These loans typically have a little higher rate because of the higher risk.
Lending Guidelines in General
It’s important to understand that the guidelines of any loan are their to balance the ratio between the risk of lending the money and the reward of getting paid back with interest. Guidelines are adjusted over time based on the performance of a large number of loans. When institutional investors see patterns in defaults, they adjust the guidelines accordingly. This is also true of pricing / interest rates. For example, while FHA technically doesn’t have minimum credit score requirements, most lenders have underwriting guideline overlays that are stricter than FHAs (this is true with VA to some extent and with conventional loans) that require a minimum score of 600 (some even require 620). We can go as low as 580 but the debt ratio requirements are tighter as well as a few other guidelines.
Interest Rates and Credit Scores
In addition to having better guidelines with higher credit scores, rates also get better with higher scores. Mortgage interest rates in general are determined by the prices of mortgage bonds that are bought and sold, typically by institutional investors, in the bond market. Rate / yield move inversely to price so as bond prices go up, the corresponding interest rates go down. I am working with a client right now whose mid-credit score was 638. Her rate based on that score was 4.5%. I recommended a couple of things that would raise her score and after she did them, she got her score up to 657. Her rate went down to 4% based on that improvement in score. Being in that higher credit score bucket (640+ for FHA; there’s also another smaller improvement at 660+) doesn’t always equate to .5% in rate because it depends on the yield curve (which is another discussion for another day). VA rates are basically the same as FHA rates with a very minor difference – there is .25 in points on a VA loan but that is often not even noticeable. Conventional is typically higher than government loans (FHA and VA) and are much more sensitive to credit scores. While conventional loans can be done with credit scores below 720, rates are much better when the mid-score is 720 or higher. Between 680-699 and 700-719, rates for both the mortgage and mortgage insurance will be higher than if the score is 720 or better and they will be noticeable. If your score is below 720 (or you aren’t sure what it is), it’s best to meet with me a few months (the more the better) before you want to buy a home so that we can see exactly what your credit score is and why it is what it is so that I can make some recommendations as to what can be done to get it to where you can get the best rate.