Have today’s historically low interest rates caused you to consider refinancing your home mortgage? If so, you are certainly not alone. Mortgage refinancing jumped to a three-year high the week ended September 28, 2012, according to data compiled by the Mortgage Bankers Association.1 Refinancing activity declined as normal over the last few weeks of 2012 mainly due to the holidays.
Not surprising, the financial standards imposed by lenders are considerably more stringent today than they were in the go-go days prior to the housing crisis. And to qualify for a refinancing at today’s historically low interest rates you need to demonstrate a good credit history and a respectable credit score.
A Numbers Game: FICO® Scores
The FICO® score (an acronym for its creators, the Fair Isaac Corporation) is a number that summarizes your credit risk. Lenders use it to gauge how likely you may be to repay debts on time and to make credit decisions, such as the interest rate you get when you apply for a loan. How widespread is the use of FICO scores? Ninety of the top 100 largest U.S. financial institutions use the FICO score to make consumer credit decisions.2
A typical credit score will range between 300 points and 850 points. Generally speaking, higher scores are presumed to represent lower risks—the more attractive your score might be to a lender, the better the pricing you may be offered and the more money you may save over time.
For instance, at current rates, a borrower with a credit score of between 760 and 850 can expect to pay a rate of 3.072% on a 30-year, $300,000 fixed-rate mortgage, according to myFICO.com’s Loan Savings Calculator. By contrast, an individual with a score of between 620 and 639 can expect a rate of 4.661%, which amounts to an extra $273 in monthly payments and an additional $98,063 in total interest paid over the life of the mortgage.3
Factors That Determine Your Credit Score
Credit reports—and the subsequent credit scores that are generated from them—are compiled by the three major credit reporting agencies—Equifax, Experian and TransUnion—based on information provided by creditors. These agencies generate scores using a proprietary formula that assigns weightings to five main factors:
Payment history. On-time payments are an important component of your credit score. Using your credit responsibly and paying bills on time are great ways to maintain a good credit score.
Credit utilization. Credit utilization is defined as the total debt you have divided by the total available credit that is available to you. High credit utilization can be a warning sign of credit risk.
Note: You do not have to carry a credit card balance from month to month to show credit card utilization. Simply using your card is enough to show activity, even if you pay the balance in full and never accrue interest. Credit card balances are reported by the issuer every 30 days based on the balance on that particular day. There is no distinction between revolving and paid-in-full balances on your credit report.4
Length of credit history. Credit history is a significant component of your credit score. Accordingly, the average age of your credit cards can be a strong indication of your credit history. Care should be used in keeping old accounts open and in good standing.
Mix of credit accounts. Both the total number of credit accounts you have and the mix of credit you have will affect your credit score. A healthy mix of revolving credit cards, charge cards, installment loans and mortgages will also impact your credit score.
The amount of new credit on your record. While opening one new credit card might be normal, opening several in a short span of time could be a warning sign to potential creditors that something is amiss in your financial life.
1Source: The New York Times, “Refinancing Spikes as Mortgage Rates Fall,” October 3, 2012.
2Source: myFICO.com, January 22, 2013.
3Source: my FICO.com, Loan Savings Calculator, January 16, 2013. The rates shown are averages based on thousands of financial lenders, conducted daily by Informa Research Services, Inc. The 30-year fixed home mortgage APRs are estimated based on the following assumptions. FICO scores between 620 and 850 (500 and 619) assume a Loan Amount of $150,000, 1.0 (0.0) Points, a Single Family Owner Occupied Property Type, and an 80% (60-80%) Loan-to-Value Ratio.
4Source: CreditKarma.com, January 22, 2013.
Todd Hauer is a Wealth Advisor and Senior Investment Management Consultant with the Global Wealth Management Division of Morgan Stanley in Denver. He can be reached at Todd.Hauer@morganstanley.com or 720.488.2406.
The information contained in this article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. Investing involves risks and there is always the potential of losing money when you invest. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Wealth Management, Member SIPC, or its affiliates. Morgan Stanley Wealth Management LLC. Member SIPC.
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