Americans with near-perfect credit scores are reaping the rewards of record-low mortgage rates, a trend that underscores the economic divide created by the coronavirus recession.
The typical credit score for mortgage borrowers remained at 786 in the fourth quarter, matching a record high set in the third quarter, the Federal Reserve Bank of New York said this week in a report. That’s the highest level in at least two decades. During the era of loose lending that led to the Great Recession, the median credit score of mortgage borrowers fell as low as 707.
Meanwhile, only a quarter of borrowers who landed home loans during the October-through-December period had credit scores of less than 737. And just 10 percent had credit scores below 687, according to the New York Fed’s data.
The numbers have been skewed upward in part by the large share of mortgage refinancings in 2020. People who already own homes generally have higher credit scores than first-time buyers.
What’s more, mortgage lenders grew more risk-averse during the coronavirus pandemic. In the early months of the recession, mortgage brokers described being required to complete near-obsessive verifications of borrowers’ employment and incomes.
A symptom of the K-shaped recovery
Americans’ fortunes have diverged widely during this recession. Those who can work remotely have continued to collect paychecks. Home prices have soared, and stocks have recovered the value they lost earlier in the year.
However, lower-wage workers struggle as restaurants, hotels and other service-sector employers continue to be battered by the pandemic. Economists have invoked the K-shaped recovery to describe the disconnect — affluent Americans’ fortunes are rising like the top half of the letter, while the working classes are experiencing the downward slope of the bottom half of the K.
“A symptom of the K-shaped consumer recovery is that those on steady financial footing or with higher incomes are able to buy a home or refinance the mortgage on an existing home,” says Greg McBride, CFA, Bankrate chief financial analyst. “The pool of borrowers in 2020 seems to increasingly come from the upper leg of the K.”
The highest possible credit score in the FICO system is 850. A score higher than 740 is considered excellent.
“A FICO score is not an indication of wealth,” says radio host and author Chris Hogan, a personal finance expert. “It’s more of an indication of how you’ve dealt with debt.”
Rising scores come with an upside for both lenders and borrowers: A homeowner with a credit score approaching 800 is exceedingly unlikely to default. For borrowers, that means little risk of a financially devastating foreclosure.
“If you sign on to buy a home before you’re ready, it can be more of a curse than a blessing,” Hogan says.
What you can do
Your credit score is the single most important factor in determining your mortgage rate. Here’s how you can boost it — and what to do if your score won’t go any higher:
Pay down credit card debt: If you have a choice between tackling debt or scraping together a larger down payment, it’s wiser to focus on the debt, because that should improve your credit score.
Pay monthly bills on time: Payment history plays the biggest part in your credit score. To keep from forgetting to write a check, automate your routine payments. To avoid a missed payment, build your emergency savings.
Consider an FHA or VA loan: Compared to conforming loans backed by Fannie Mae and Freddie Mac, mortgages backed by the Federal Housing Administration and the U.S. Department of Veterans Affairs carry less stringent rules about credit scores. However, the upfront fees are higher.
Know when enough is enough: The best mortgage deals go to borrowers with scores above 740, but improvements beyond that point won’t do much to affect your rate. Keep an eye on your score, of course, but understand that boosting it from 790 to 800 won’t get you a better deal.