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By Robert Lee | Agent in Libertyville, IL

The Importance of your Credit Scores

Defining Your Credit Scores

A person who has recently paid his bills on-time should continue to pay his bills on-time in the near-future.  This is the basis of credit scoring; using your past to predict your future.  Higher credit scores correlate with lower default risk which explains why people with high credit scores tend to receive lower mortgage rates than people with low credit scores.

There are five factors that comprise the credit score. Payment history accounts for 35% of the score; outstanding credit balances have a 30% impact; credit history makes up 15%, type of credit factors at 10%; and inquiries influence the score by 10%.

Credit Scores Change Mortgage Rates

Your FICO score has always influenced the mortgage rate for which you’re eligible. In 2008, though, it began to change your loan fees. (You have three FICO scores one from each credit bureau)

In response to major mortgage market losses, in April 2008, both Fannie Mae and Freddie Mac introduced something called Loan-Level Pricing Adjustments (LLPA). Loan-level pricing adjustments are “discount points” added to a mortgage rate, based on a specific borrower’s risk to the lender.

A discount point is a loan fee, paid at the time of closing. 1 discount point is equal to 1 percent of your loan size.

Example : A $300,000 mortgage that’s assessed 1 discount point will have $3,000 in extra fees due at closing.

Fannie Mae and Freddie Mac know that low credit scores correlate to high default rates so, like an insurance policy, they assigned the highest costs to the highest-risk borrowers.

Assuming a 20% downpayment, look at how discount points change based on credit score. Fees get massive for FICOs under 700.

  • 740+ FICO  : There are no discount points required. This loan is “low risk”.
  • 720-739 FICO :  0.250 discount points are charged to the borrower, or $250 per $100,000 borrowed
  • 700-719 FICO :  0.750 discount points are charged to the borrower, or $750 per $100,000 borrowed
  • 680-699 FICO :  1.500 discount points are charged to the borrower, or $1,500 per $100,000 borrowed
  • 660-679 FICO :  2.500 discount points are charged to the borrower, or $2,500 per $100,000 borrowed

Now, not many new home buyers just have that kind of extra cash just laying around. Therefore, as an alternative to paying discount points with cash, many choose to “roll up” the fees into their respective mortgage rates. In general, 1.000 discount point can be “traded in” for a 0.250 increase to your mortgage rate.

Example : A consumer with a 680 FICO score is required to pay 1.500 discount points at closing, or can alternatively accept a mortgage rate increase of 0.375%.

This is why it’s important to keep your credit score high. There are real dollar costs for having scores under 740.

Reference: http://goo.gl/qRnci

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