It’s something few homebuyers understand but more should. It’s the importance of your credit score when buying a home, especially if you have a low down payment and must buy private mortgage insurance.
Private mortgage insurance, known as PMI, protects the lender’s investment when the borrower pays less than 20 percent down. When the homebuyer reaches 20 percent equity, PMI is not required and there are several ways to get rid of it. Until then, the buyer must pay a monthly insurance premium, in addition to the mortgage.
Credit score is used to determine PMI eligibility, price
Insurers, like mortgage lenders, look at your credit score when determining your PMI eligibility and cost.
“I would say it’s one of the bigger drivers of how mortgage insurers tend to price,” says Steve Keleher, senior vice president of portfolio management and pricing at Radian, which offers PMI and a suite of other mortgage and real estate services. “We protect the lender and investor; anything that increases the likelihood of delinquency and foreclosure increases the cost.”
Insurers also put a lot of weight on the size of your down payment and your debt-to-income ratio. “In general, private mortgage insurance is available for borrowers with credit scores as low as 620 with down payments as low as 3 percent,” says Anthony Guarino, senior vice president of pricing and credit policy for Genworth Mortgage Insurance.
Many homebuyers required to buy PMI
Private mortgage insurance is a common cost, especially for first-time homebuyers, who accounted for one-third of home purchases in 2019, according to a survey by the National Association of Realtors.
First-time buyers typically paid down 6 percent, financing 94 percent of their home purchase, the NAR survey says, while repeat homebuyers typically paid 16 percent down, financing 84 percent of the purchase price. Repeat buyers often have the proceeds of a home sale to use toward a down payment, enabling them to borrow less.
The annual cost of PMI is typically expressed as a percentage of the loan amount and is paid in equal monthly payments. So, the more you borrow, the higher your PMI payment.
Credit scores and PMI rates are linked
PMI costs have a broad range, roughly 0.25 percent to 1.5 percent of the amount borrowed. Insurers use your credit score, and other factors, to set that percentage. A borrower on the lowest end of the qualifying credit score range pays the most.
“Typically, the mortgage insurance premium rate increases as a credit score decreases,” Guarino says. He offers this example:
A house sells for $333,333 and the borrower pays 10 percent down, leaving an outstanding loan balance of $300,000 with a 30-year, fixed-rate mortgage. A borrower with a “very good” FICO credit score (at least 740) might pay 0.20 percent to 0.30 percent of the loan balance for PMI, or $50 to $75 a month, says Guarino.
A borrower with a “good” FICO credit score (670-739) will pay more than the “very good” borrower, says Guarino, estimating 0.35 to 0.40 percent of the $300,000 mortgage, or $80 to $100 a month.
But a homebuyer with only “fair” credit, in the neighborhood of 620-660, might pay 0.75 to 1.50 percent of the loan balance, or $188 to $375 per month, Guarino says.
“A small change in credit score, 1 to 10 points, may have limited impact,” Guarino notes, “but a lower credit score ranging from 620 to 660 could result in a cost two to three times that of someone with an outstanding credit range of 760 to 800.”
Mortgage insurance for FHA loans works differently, but your credit score still counts when it comes to how much you pay.
There are a number of steps you can take to improve your credit score, especially if you plan to buy a house. “Credit score is one of those things that can drive tangible savings,” Keleher says. “That is something within the borrower’s control and will have a benefit when it comes to a mortgage loan.”
A good credit score can save you tens of thousands of dollars in interest on a mortgage. Use Bankrate’s mortgage calculator to estimate your monthly payment.
PMI paves a path to homeownership
Private mortgage insurance is an added cost of homeownership that buyers dread, but the fact is, many people would not be able to buy a home without it. PMI opens doors for borrowers who can’t get over one of the biggest hurdles to homeownership: the 20 percent down payment.
PMI has helped more than 30 million families nationwide to become homeowners over the past 60 years, according to the U.S. Mortgage Insurers, a trade association.
“One of our goals is sustainable homeownership,” says Keleher, of Radian. “We can help borrowers purchase homes sooner than they would otherwise be able to. We are insuring the American Dream in a sustainable way.”