“When to apply for a mortgage: now or after improving my credit score?” It’s the age-old question you probably hear every day from your clients.
Buying a home is an exciting milestone. However, it comes with challenges – and deciding when to apply for a mortgage is one of the biggest. Should your clients jump in now, or would they be better off waiting until their credit score becomes stronger? Timing plays a critical role in the mortgage process. It can greatly impact the terms and affordability of a loan. With so much at stake, your borrowers turn to you for guidance. But the answer isn’t always straightforward. It depends on several factors, including credit scores, current interest rates, and the state of the housing market.
In this article, we’ll break down the key considerations to guide you through this decision-making process. You’ll learn why a good credit score matters, how market conditions affect timing, and the advantages and drawbacks of applying for a mortgage now versus waiting. Armed with these insights, you can provide your clients with the expert advice they need to make the right choice.
The Importance of Credit Scores in Mortgage Applications
How Credit Scores Impact Mortgage Approval
A credit score is a numerical summary of a person’s credit history. It reflects how well they’ve managed their debt over time. It considers factors such as payment history, outstanding balances, and the length of credit history. Mortgage lenders rely on these scores to assess a borrower’s financial credibility. It helps determine the level of risk involved in lending to them.
A strong credit score indicates a lower perceived risk in the eyes of the mortgage lender. On the other hand, a lower credit score suggests a higher risk.
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When your clients apply for a mortgage, lenders pull their credit reports and calculate their credit scores. A strong credit score signals to lenders that your client is a reliable borrower. It increases the chances of getting approved for a mortgage. Lenders see it as a sign of financial responsibility, trustworthiness, and a high likelihood of timely repayments. A poor credit score, in turn, can even lead to rejection in some cases. When it comes to mortgage approvals, “there is no ‘official’ minimum credit score since lenders consider additional factors,” as Investopedia points out. In addition, “each lender also has its own strategy, so while one lender may approve your mortgage, another may not – even when both use the same credit score.”
Credit Scores and Interest Rates
Credit scores also have a direct impact on mortgage interest rates and loan terms. A high credit score can lead to lower interest rates. This acts as a reward for responsible financial behavior. Lenders are more willing to offer lower interest rates to borrowers with good credit because they pose less risk. Lower interest rates can save your clients thousands of dollars over the life of their mortgage. Also, lenders may offer borrowers with high scores more favorable terms. These can include a longer loan term or lower down payment requirements. For those with lower scores, the interest rates are often higher, leading to a more expensive loan overall.
It’s important to note that, according to myFICO, “90% of top lenders use FICO Scores to help them make billions of credit-related decisions every year.” So FICO is the most important scoring model to focus on.
How Credit Scores Affect Mortgage Interest Rates
As we’ve already mentioned, a credit score directly affects interest rates. However, it’s essential to demonstrate to your clients how their credit score can translate into real dollar amounts. While borrowers may generally understand that higher credit scores lead to better interest rates, specific examples can illustrate just how much is at stake.
Imagine two borrowers, both with similar financial situations but with different credit scores. Borrower A has an excellent credit score of 780, while Borrower B has a fair credit score of 650. Using this year’s average loan amount of $405,400, as reported by the Mortgage Bankers Association, consider their outcomes on a 30-year fixed-rate mortgage.
According to myFICO’s Loan Savings Calculator, Borrower A, with a higher credit score, could qualify for an APR of about 7.167%, resulting in a monthly payment of $2,743. Meanwhile, Borrower B, with a fair credit score, could be offered a higher rate of around 7.687%, raising their monthly payment to $2,887.
At first glance, the difference of $144 per month might not seem overwhelming. However, over the life of the loan, the total costs tell a different story. Over the 30-year life of the loan, Borrower A, with the lower interest rate, would pay $581,992 in total interest. Borrower B would pay $633,814. Overall, Borrower B would pay an extra $51,822. This amount could be saved or invested elsewhere simply by improving their credit score before applying for a mortgage.
It’s crucial to emphasize this long-term perspective to your clients. While a few percentage points may not seem like much at first glance, they can have a substantial impact on their overall financial health.
Signs You Should Improve Your Credit Before Applying
Deciding when to apply for a mortgage can feel like a balancing act for your clients, especially if their credit profile has room for improvement. Sometimes, it’s better to pause and work on improving their credit score before starting the mortgage application process. Certain signs may indicate that improving their credit scores could significantly benefit them in the long run.
High Debt-to-Income Ratio
One major red flag is a high debt-to-income ratio (DTI). This ratio compares your clients’ monthly debt payments to their monthly income. Lenders use it to gauge their ability to handle additional debt, like a mortgage. A high DTI (typically above 36%) can signal to lenders that a borrower is financially overextended, even if their credit score meets minimum requirements. This may ultimately make it more difficult to get approved for a mortgage or result in less favorable terms. In this case, reducing existing debt can improve their chances of approval and potentially secure better terms.
Recent Negative Credit Events
Another red flag is recent negative credit events. Late payments, defaults, or bankruptcies leave marks on credit reports that weigh heavily on a borrower’s score. Even if these events are months old, their impact may still be enough to concern lenders, as negative items remain on your clients’ credit reports “for up to seven years. The one exception is Chapter 7 bankruptcy, which expires after 10 years.”
If your clients have experienced these issues, it’s wise to take some steps to improve their credit before applying for a mortgage.
Credit Score Near a Higher Tier
Sometimes, small credit improvements can have a big payoff. FICO scores are grouped into tiers: poor (300-579), fair (580-669), good (670-739), very good (740-799), and exceptional (800-850). A client whose score is just shy of moving to the next tier could benefit from waiting and working on their credit. For instance, raising a score from 730 to 740 could qualify them for significantly lower interest rates. It will save them thousands over the life of their mortgage.
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Helping your clients recognize these signs will ensure they don’t rush into the process before they’re ready. By identifying areas for improvement and explaining how these changes affect their mortgage options, you can guide them toward better financial outcomes.
Strategies to Improve Your Credit Score Quickly
If you’ve determined that your clients’ credit scores have room for improvement, it’s time to implement strategies to boost them. Here are some practical steps to help your clients get into a stronger financial position.
Check and Correct Credit Reports
The first step is to review credit reports. The three major credit bureaus – Equifax, Experian, and TransUnion – are authorized to provide annual credit reports. You can access them for free at AnnualCreditReport.com. Encourage your clients to carefully check their reports for errors, such as incorrect late payments or outdated account balances. Disputing these inaccuracies can help eliminate issues that may unnecessarily lower their credit scores, potentially leading to noticeable improvements.
Pay Down High Balances
About 30% of a FICO score is based on outstanding debt. So, paying down credit card balances is one of the most effective ways to improve credit quickly. Encourage your clients to prioritize paying down accounts with high balances relative to their limits, as this directly affects their credit utilization ratio.
Avoid New Credit Inquiries
Every time someone applies for credit, it can result in a hard inquiry on their report, which means a lender checks your client’s credit report to assess their creditworthiness before approving a loan or credit card. This inquiry is a red flag for lenders because it suggests that a borrower may be taking on more debt than they can handle. Multiple hard inquiries within a short period can significantly lower a credit score. So advise your clients to refrain from opening new credit cards or taking out new loans while they’re working on improving their credit.
Make All Payments on Time
Timely payments are the most critical factor in credit scoring, accounting for 35% of a FICO score. Even a single missed payment can have a significant and lasting impact. For example, according to NerdWallet, “a payment that’s more than 30 days past due can knock as many as 100 points off your credit score.” That’s why it’s important for your clients to make sure all their bills are paid on time. Sometimes it can be overwhelming to keep track of all the due dates, so setting up automatic payments or reminders can be an effective solution.
Reduce the Credit Utilization Ratio
Credit utilization – “the balance on credit cards compared with available total credit” – is another crucial scoring element. Reducing the credit utilization ratio to below 30% can significantly improve scores. This means keeping credit card balances low relative to the total available credit limit. Your clients should aim to use only a small portion of their available credit, pay down balances, and avoid new credit to demonstrate responsible borrowing behavior.
When It Makes Sense to Apply Now
While a strong credit score can lead to lower interest rates and better loan terms, there are certain situations where the benefits of applying now outweigh the potential drawbacks of a slightly lower credit score. Let’s take a closer look at how to identify these scenarios.
Rising Interest Rates Environment
In a market where interest rates are climbing, time is critical. If interest rates are expected to increase significantly in the near future, it may be more advantageous for your client to apply for a mortgage now, even if they have to pay a slightly higher interest rate; delaying could cost them more in the long run. As a mortgage professional, you can help your clients weigh whether the urgency of locking in today’s rates outweighs the potential benefits of waiting.
Stable Credit but Market Opportunities
A less-than-perfect credit score doesn’t always mean it’s necessary to wait. If it’s still stable but not excellent, and you see favorable conditions in the housing market, such as declining home prices or increasing inventory, it could be a good time for your client to apply for a mortgage. A higher credit score might get your client a better deal, Still, the potential savings from buying a home at a low price could offset the higher interest rate.
Personal Circumstances
Sometimes, life events drive the need to act quickly. Whether it’s relocating for a job, accommodating a growing family, or addressing other pressing needs, waiting to improve credit may not be practical. If your clients have stable income and a manageable budget, applying for a mortgage now – even with an average credit score – can be the right move to meet their immediate needs.
Remember, deciding when to apply for a mortgage is about choosing what’s best for the situation, not just striving for a perfect credit score.
Balancing Immediate Needs with Long-Term Benefits
Deciding when to apply for a mortgage requires a careful balance between meeting immediate needs and focusing on long-term financial goals. It’s essential to assess your client’s financial situation holistically and consider all factors before making a decision. So how do you do this effectively?
Assess the Financial Situation
Start by encouraging your clients to take a step back and evaluate their overall financial health. This includes assessing their income, expenses, and debt obligations. Creating a detailed budget can help them identify areas where they can cut back and save more money. By understanding their current financial situation, they can avoid taking on more debt than they can manage.
Consult with Professionals
While your expertise as a mortgage professional is essential, a broader perspective on overall financial health is often needed. Consider referring your clients to other industry experts, such as financial advisors or credit counselors. These professionals can help them understand whether improving their credit score first could lead to better terms or whether their financial readiness means they should move forward now.
Consider Pre-Approval
Pre-approval can be a valuable step for your clients, giving them a better understanding of how much they can borrow and what interest rate they can qualify for. It can also strengthen their negotiating position when they make an offer on a home. But it’s important to use it strategically. A hard inquiry, which is required for pre-approval, can temporarily lower your client’s credit score. Make sure your clients are aware of this trade-off so they can decide if pre-approval is in line with their current goals. If they’re planning to make a purchase in the near future, the benefits of pre-approval often outweigh the minor credit impact. If they’re still working to improve their credit, waiting may be a better option.
Conclusion
So, wait or apply? That’s the million-dollar question on your borrowers’ minds as they get closer to homeownership. But now you have the knowledge to help them make the right decision.
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Waiting to improve their credit can give them access to lower interest rates and better loan terms, potentially saving them thousands over time. But time isn’t always on their side. Rising interest rates and a competitive housing market can make delaying a costly decision. The key is to understand their financial situation. Can they comfortably manage a mortgage payment now, or would a few months spent strengthening their credit position them for a better deal? Remember, the decision hinges on your borrowers’ unique circumstances, and a less-than-perfect credit score doesn’t mean they can’t secure favorable terms.
Not sure what to recommend? Contact A&D Mortgage today to discuss your clients’ specific needs and explore the best path forward.
