Your FICO score will be a determining factor in the setting of the interest rate on your mortgage. Put simply, your FICO score is a risk rating on you, the borrower. Data related to your financial responsibility is aggregated by institutions that you do business with, and it is this data that comprises your FICO score or credit score. So what exactly makes up your FICO score and how will it affect your mortgage interest rate and your monthly payments?
There are five basic components with respective percentages that make up your FICO score. They are payment history 35%, amounts owed 30%, length of credit history 15%, new credit 10%, and types of credit used 10%. As indicated by the aforementioned percentages, payment history carries the most weight in the composition of the score. Mortgage lenders need borrowers with exceptional payment histories so they can forecast future profit. To secure future profits, a lender needs to know that borrowers will be able to pay well into the future. The servicing of past debts is an excellent predictor of the servicing of future debts; consequently, if you have been on time with the vast majority of your debt payments in the past, you will be a profitable consumer into the future, and therefore an acceptable mortgage risk.
Payment history does not just include the payment history on prior mortgages. It includes a long list of financial data; everything from the most obvious-credit cards- to the not so obvious, such as how completely you fulfilled your promises of repayment on a past due shopping credit line. Data that is an extension of direct financial transactions will also be included in the payment history component of your credit score. Examples of this data are liens, garnishments, judgments, and bankruptcies. Understanding how to build a complete profile of yourself, by yourself, is crucial to your financial success in the 21st century. If you entered a financial transaction with credit or an account held by computer data bases, any and all of this information will be used by lenders to asses you as a risk to profitability.
Amounts owed comprises 30% of your credit score, and even if lenders don’t directly use the variables that constitute the amounts owed on a FICO score they will definitely be using some measure of your current debt and servicing of that debt to determine if they will be paid in full and on time. Before taking out a mortgage, paying off as many debts as possible is a great idea. Being less of a risk is quite desirable and will allow you to shop around for the most competitive rates. Your credit score is a good indicator of you as a risk to a lender, and accordingly institutions will use it as a way to set your mortgage interest rate, and consequently your monthly loan amount. A common analysis, used to illustrate the vast difference in rate and payments terms, on a loan, is to analyze a $300,000 loan and what a good credit score and a bad credit score would have to pay.