When you apply for a mortgage loan, one of the first things your loan officer does before quoting you an interest rate is pull your credit report. By reviewing your credit scores and past financial history, your lender calculates your interest rate based on your risk of default. Risk categories are graded as A, B, C, D and F, with A representing the lowest amount of risk. The lower your risk category, the higher your interest rate.
Unlike individuals in the “A” credit tier, who have the highest scores and receive the lowest interest rates, if you fall into the “B,” “C” or “D” credit tier, you've likely had credit problems in the past. These problems resulted in lenders reporting negative information to the credit bureaus. Negative reports lower your credit scores and indicate to lenders that you represent a higher risk of default than an individual without past credit problems. Because of this, you won't be eligible for your lender's lowest rates, and you'll pay more for your mortgage over the life of the loan.
Although lenders' criteria regarding what constitutes each credit tier may vary, “B” credit buyers generally have credit scores ranging from 620 to 650 and may carry one or two late payment notations for the last 12 months. If you have “C” credit, your credit score is slightly lower -- from 580 to 619 -- and your history may include several 30-day and 60-day late notations from creditors. Prospective buyers with “D” credit are in much worse shape. If your risk level falls into this tier, your credit record probably reflects numerous late payments and possibly a recent bankruptcy, and you may not qualify for a mortgage at all.
Increasing Credit Tier
You can improve your credit tier and qualify for a lower interest rate by working to improve your credit scores. You have the right to a free copy of your credit record from each credit bureau every 12 months. If you discover errors on your reports that are dragging down your scores, you can dispute these errors with both the credit bureaus and the creditor that made the erroneous report. Paying down high credit card balances and always paying your debts on time will also help your credit gradually improve.
In the fight to raise your credit scores, time is your greatest ally. Most negative information falls off your report after seven years. If you've practiced smart debt management during that period, you should see a considerable jump in your credit scores when the credit bureaus remove old negatives.
Factors to Consider
Although your credit tier is an important factor that determines whether you qualify for a mortgage and the interest rate that mortgage carries, other aspects of your financial history also impact your eligibility for a loan. For example, a high credit tier won't override your lack of income if you cannot comfortably afford the house you want.
The amount of debt you carry also impacts your ability to qualify. Even if your income and credit scores are acceptable, if you have too many financial obligations, your lender may question whether you can afford your mortgage along with your other debts. Thus, its crucial to get your entire financial picture in order -- not just your credit -- before you apply for a mortgage loan.
Ciele Edwards holds a Bachelor of Arts in English and has been a consumer advocate and credit specialist for more than 10 years. She currently works in the real-estate industry as a consumer credit and debt specialist. Edwards has experience working with collections, liens, judgments, bankruptcies, loans and credit law.