Which Is More Important: Down Payment or Credit Score?

Many potential homeowners focus on building up savings for their down payment (which is great!), but forget about the importance of credit scores. While a higher down payment can lead to better terms and lower interest rates on a mortgage, it may not always be feasible since it requires more money upfront and additional time to acquire those funds. Building up your credit score can be the key to saving money in the long run and provide more of an immediate impact on your rate. In the rest of this article, we will explore the financial benefits of not putting 20% down on a mortgage (unless it makes sense for your financial picture) and the ways that a better credit score can decrease the cost of a mortgage. Also, I want to suggest a few steps on how to increase your credit score. So, let’s begin!

Why Not Putting 20% Down Can Be a Good Idea

While putting 20% down on a mortgage can help you avoid private mortgage insurance (PMI), it can also deplete your savings and leave you exposed to other financial risks. For one thing, you may miss out on investment opportunities (stocks, real estate, etc.) or emergency funds that you could have used the money for in the event an unforeseen circumstance happened (those never happen though, right?).

Another advantage of putting less than 20% down is that it allows you to redirect your savings towards other financial goals, such as paying off outstanding debts that you have not been able to chip away at. By paying off debt, you can improve your credit score and get a better deal on your mortgage over time.

How a Better Credit Score Can Lower Your Mortgage Cost

Your credit score can have a significant impact on your mortgage cost, as it determines the interest rate you’ll pay and the amount of PMI (which can vary between 0.2%-2% of the loan amount) you’ll be charged. A better credit score can also make it easier to qualify for a mortgage and can help you acquire a better rate with your lender

For instance, if you have a credit score of 620, your interest rate could be around 0.75% higher than someone with a score of 740 or above. This means that a $250,000 mortgage could cost you an extra $150 per month or $54,000 over the life of the loan. Similarly, if you have a credit score of 680, you could be charged almost $150 per month for PMI in this scenario, while someone with a score of 760 or above could be required to pay a fraction of that for PMI.

Steps to Improve Your Credit Score

If you’re considering a mortgage in the near future, it pays to take steps now to improve your credit score. Here are four actions you can take:

1) Make on-time payments. On-time payments are essential for building good credit. Set up automatic payments or reminders to ensure you are never late on a payment.

2) Pay off your debts. Paying off your debts can help you lower your credit utilization ratio, which accounts for 30% of your credit score. Try to pay off high-interest debts first, and then focus on the rest.

3) Avoid new credit applications. Applying for new credit can hurt your credit score by adding hard inquiries to your report. Only apply for new credit if you really need it, and avoid opening too many new accounts at once.

4) Monitor your credit score regularly. Check your credit score regularly to see how your efforts are paying off. You can get a free credit report from each of the major credit bureaus once a year, or you can sign up for a credit monitoring service.

Buying a home is a big financial decision, but the hope is that with these steps and perspectives that it makes it not seem so daunting. By focusing on your credit score and not just your down payment, you can save yourself a lot of money on your mortgage over time. If it is your first time buying a home, there are many scenarios that you can put as little as 3.5% towards your down payment. Always remember that even small improvements to your credit score can have a big impact, so don’t be discouraged if you don’t see results right away. All good things take time. I leave you with a famous quote by Jean-Jacques Rousseau, “Patience is bitter, but its fruit is sweet.” With time, patience, and dedication, you can achieve the credit score you need to get the best possible deal on your mortgage, and really, just about anything else.

This is not financial advice. For educational purposes only. Before making any financial decisions, consult with a professional.