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How Does My Credit Score Affect My Mortgage?

From the time that mortgage companies started using FICO scores in the mid-1990s to gauge a borrower’s so-called “credit worthiness”, there has been a common belief that the higher a person’s income, the higher his credit score would be.  According to a recent article by Kenneth Harney, that appears to be a bit of a mortgage myth.

Harney cited a recent FHA study that found that the agency’s lower-income borrowers generally had higher FICO scores than their higher-income counterparts.

So what does this mean to you?  Should you aim to earn less money so that your credit score can go up?  My first thought would be…um, no.

Neither Harney nor FHA Commissioner Brian D. Montgomery, who is cited in the story, provides the reasons behind this apparent anomaly.  In my own mind, it may be that homeowners-or potential homeowners-with limited incomes are more accustomed to accounting for every dollar that comes in and out of their bank accounts and are more cautious about debt as a result.  It could also be that lower income borrowers use a more graduated approach in their real estate purchases, buying low-cost starter homes, selling at a modest price, purchasing a slightly more expensive mid-range home, etc.

In the alternative, those with higher incomes may believe that they can assume more debt and pay less attention to their spending habits, thus being more likely to be at risk to miss a payment and damage their credit rating.

Whatever the reason, FHA is now recognizing that those with higher credit scores-and thus a lower risk to lenders-should not pay the same mortgage insurance premium (MIP) as those with lower scores.  And their new program will significantly benefit lower-income borrowers.

In the past, everyone who purchased or refinanced with an FHA-insured mortgage paid exactly the same MIP: 1.5 percent of their loan amount upfront, then .5 percent annually.  Under the new plan, which may roll out as early as July, upfront MIPs may be as low as 1.25 percent for borrowers with larger down payments and better credit scores,  and may climb to 2.25 percent for those with lower down payments and credit scores.  Annual premiums will also fluctuate from .5 percent to .55 percent, again based on credit scores.  FHA will pull multiple credit reports and use the middle credit score if three are pulled, or the lowest score if only two reports are used.

FHA loans are also changing in other ways, which I’ll address later.  In the meantime, remember that it is important to keep your credit score as high as possible.  That means keeping a “healthy” balance of open credit, making your payments on time, and limiting the inquiries into your credit report.  It’s also a good idea to get your free credit report every year to prevent potential ID theft.  After all, keeping your credit score up can keep your payments down in the future.