Buying a house is probably the largest single financial decision people ever make -- and it's a decision that's made with high frequency each year.
Following the end of the steepest recession this country has seen since the Great Depression, total home sales have rebounded from nearly 4.6 million in 2011 to 6.1 million by 2017. Though these figures have somewhat leveled off in recent years, total home sales continue to hover around 6 million, spurred on by historically low lending rates and the longest economic expansion in U.S. history. It would seemingly look like a great time to buy a house, but that all dependents on if you have your credit in order.
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Saving money on a home is easy, if you have an excellent credit score
You see, there's more to buying a house than simply negotiating on the purchase price. Most Americans aren't walking around with hundreds of thousands of dollars in disposal income, meaning the vast majority of home purchases are made with the aid of a bank or credit union acting as a lender for the buyer. This means that not only will the eventual price you pay for your home include the initial purchase price you agree on with the seller, but also the interest you pay on your loan -- and this interest rate very much depends on your credit score.
According to data from Zillow, as of Dec. 31, 2019, the median listing price for a home throughout the U.S. was $282,000. With a majority of Americans leaning on 30-year fixed-rate mortgages as their financing tool of choice, this gives lenders a long time to reap the rewards of their loans.
Just how much of a difference could there be in the total cost of a loan, inclusive of interest paid, based on credit score? A lot, actually.
As of Jan. 16, 2020, the national average annual percentage rate (APR) for a 30-year fixed rate mortgage for persons with FICO credit scores of between 760 and 850 (850 being the highest possible score) was 3.332%. By comparison, those folks with credit scores of 660 to 679 were being offered 30-year fixed-rate mortgages with an average APR of 3.945%. Over the life of the loan, assuming the full 30 years and the current median list price of $282,000, homebuyers with excellent credit scores will pay a little over $35,000 less in total loan costs than homebuyer with only a good credit score.
In other words, saving $35,000 on the median-listed home in America is really as simple as having an excellent credit score (i.e., FiCO score of 760 or higher). Yet, nearly 80% of all adults have a credit score that's under 760, as of April 2017.
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Improving your credit score begins with understanding how it's derived
What's the best way to improve your credit score? Well, it helps to understand how your score is derived, and what factors are more important than others. As you're about to see, it's really not as difficult as the statistics might suggest to move into the excellent credit category in order to secure yourself some cost-savings when buying a home.
For this discussion, I'm choosing to focus on the best-known credit-scoring system offered by FICO. Though Fair Isaac Corporation, the company behind the FICO score, is secretive about the specifics to its formula, it has offered a general reference guide of the factors that affect your credit score. The five factors are (along with their respective percentage weighting):
- Your payment history (35%)
- Your credit utilization rate (30%)
- Your length of credit history (15%)
- Your credit mix (10%)
- New credit applications/inquiries (10%)
Right off the bat, you can see that three of the five categories comprise 80% of your score. And what's really crazy is that you don't have to do much at all to make this 80% work in your favor.
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First of all, pay your bills on-time. It's really as simple as that. Paying your bills on-time makes up more than a third of your credit score and demonstrates your trustworthiness to lenders.
Secondly, be prudent with how you spend your available credit. If you wind up nearly maxing out your credit cards to their limit, you'll be viewed as a risk, thereby hurting your credit score and pushing your mortgage APR higher. The sort of unwritten rule is to keep your credit utilization rate -- i.e., your total available credit from all of your credit lines added up -- below 30%. This will demonstrate fiscal prudence and go a long way to helping improve your credit score.
Lastly, keep those credit accounts open. The longer you have credit accounts in good standing, the more evidence there is for lenders to see that you're trustworthy enough to lend money to. Even if you don't use an older credit account much anymore, make a small purchase from time to time to ensure it isn't closed. Credit accounts with 10 or more years of good history are golden!
Long story short, simply paying your bills on-time, being mindful of how you use your available credit, and keeping your credit accounts open, is practically a surefire way to a higher credit score and lower long-term home costs. As someone with a perfect FICO score of 850, let me tell you, it really is that simple.
