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Who would’ve thought one three-digit number would make such a difference?
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If you’re thinking of buying a home sooner rather than later, you may have a to-do list that includes items like finding the right real estate agent, narrowing down the neighborhoods you want to look in, and even vetting potential mortgage lenders. But there’s one big task you want to add to your list: improving your credit score.
Personal finance guru Humphrey Yang recently demonstrated the importance of having good credit and being a trusted borrower on Instagram by discussing two different potential mortgage loan applicants with different borrowing histories. The one who missed a loan payment was given a much higher monthly payment (including interest) than the one who repaid a previous loan on time. This resulted in the borrower with stronger credit paying $137,000 less in interest over the course of the mortgage term! I don’t know about you, but $137,000 is a lot of money to me.
Let’s have a closer look and break this down in real numbers to see what a higher credit score can do for you in your quest to buy a home.
A tale of two credit scores
Let’s say you’re applying for a mortgage loan and you have a credit score of 620. This is the minimum acceptable credit score to be approved for a conventional mortgage loan (meaning, one not backed by the government like an FHA or VA loan would be). The amount you’re borrowing is $350,000, and you’re getting a 30-year fixed-rate mortgage, which is “the best instrument in the world,” according to Warren Buffett. With your 620 credit score, as of this writing with current mortgage rates, you’d be looking at a monthly payment of $2,535, and paying a total of $562,538 in interest on your mortgage.
But what if you approached the process with a credit score of, say, 700? You’ll qualify for a lower interest rate (as lenders will see you as a less-risky borrower), giving you a monthly payment of $2,211, and leaving you paying $446,074 in interest — or $116,464 less than in our first scenario.
How to improve your credit score
It’s easy to see from the numbers above just how advantageous a higher credit score can be if you’re hoping to save money on your home purchase. And, let’s face it, homeownership is expensive enough as it is. So what can you do to get your credit in tip-top shape before you apply for a mortgage?
Pay down debt: Really dig in and focus on paying down your existing debts, especially if they are of the high-interest variety, like credit card debt. This will in turn free up cash to save for your down payment and improve your debt-to-income ratio, another number you’ll want to be as low as possible to get approved for a mortgage.Improve your payment habits: Your payment history makes up 35% of your credit score, so if you’ve historically been late with payments, now is a great time to get better at paying on time.Check your credit report: Credit report errors are fairly common, so it pays to check yours out (you can access your credit report for free every week until the end of 2023) and see if there are any mistakes on it. If you find any, you can ask that they be removed.
While you may not relish the thought of having one more thing to do as you prepare to buy a home, improving your credit score should really be a top priority. Having a better score will save you money on mortgage interest and make you a more attractive borrower to mortgage lenders. And isn’t that worth it?
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