The relationship between your credit score and your mortgage rate is simple: Lenders reward the most financially responsible borrowers with the best rates and products, says Lynne Pulford, senior vice president for Sandy Spring Bank's Mortgage Division.
And while your credit score is probably the biggest factor lenders use in determining your mortgage interest rate, there are other reasons why your interest rate might be higher than you expected.
Here are some surprising things that may contribute to a high mortgage rate…
Factor #1 - You're Using More than 35 Percent of Your Credit Limit
Did you know that using too much of your available credit can actually hurt your credit score and in effect, your mortgage interest rate? Well, it can, according to Harrine Freeman, a financial counselor and author of "How to Get out of Debt: Get An “A” Credit Rating for Free."
“The average credit utilization should be no more than 35 percent,” Freeman explains. Anything higher than that lowers your credit score and categorizes you as a risky borrower who may be prone to spending more money than necessary, or may not be able to meet their debt obligations, Freeman adds.
And the impact on your credit score of using too much credit can be big. According to Freeman, credit utilization higher than 35 percent can lower your credit score by 10 to 45 points - and that higher score can translate into a higher interest rate.
Factor #2 - You Don’t Have a Mix of "Revolving" and "Installment" Credit
While you can certainly get approved for a mortgage loan without having a mix of revolving (credit cards) and installment (loans, like a car loan for example) credit, Freeman says you might be able to get a lower interest rate if you have both.
So why is the mix of credit so important?
It’s simple: While revolving debt influences your overall credit score more heavily, having and paying down installment debt demonstrates your ability and willingness to manage debt responsibly, according to Pulford.
And while there’s no telling what the perfect balance of revolving and installment debt is, Pulford says that if you have a large amount of revolving debt, paying off some of that debt will improve your score and land you a better mortgage rate when you’re ready to refinance or get your first loan.
Factor #3 - You Borrowed Money for a Property that Went to Short Sale
If you borrowed money for a property that went to short sale, you may find yourself with a higher mortgage rate than you expected.
According to Experian’s website (one of the three largest credit reporting companies), a short sale basically means you sold your house for less money than you owe to the mortgage lender. The lender then reports the debt as “settled” rather than “paid.” And while this may not sound like a very big difference, these two words could be the difference between a high or low mortgage rate.
That's because a "settled" debt tells lenders that you weren’t able to make payments and had to reach an agreement to repay only part of the total debt, Experian points out. Not the impression you want to give to future lenders.
What's more, a short sale can drastically decrease your credit score, according to FICO's Banking Analytics blog.
For example, if you had a credit score of 680 and then went through a short sale, your score would likely drop to between 575 and 595, according to FICO's blog.
So if a short sale is in your financial history, this may be one factor contributing to your high interest rate.
Factor #4 - You Have a Bad History of Paying Rent on Time
Having a bad history of paying your rent on time is a problem because it could be an indication of how a person might pay their home loan, says financial counselor Chris Hogan.
And while rental histories are typically not reported to the three credit repositories (TransUnion, Equifax and Experian), Hogan says many banks and mortgage companies will ask for a 12 to 24 month rental payment history.
“These institutions want to know how well you take care of your financial obligations,” Hogan explains.
What's more, a poor rental history could eventually show up on your credit report if you are taken to court due to lack of payment, or if your delinquent account was referred to a collection agency, says Freeman.
“[Court] judgments bring down your [credit] score the most, along with bankruptcies and foreclosures,” adds Freeman.
Factor #5 - Your Spouse or Buying Partner has a Lower Credit Score than You Do
If you are purchasing a home with your spouse or significant other, his or her credit score will influence the mortgage rate you receive, according to Sheira J. MacKenzie, a loan officer with Fairway Independent Mortgage Corporation.
MacKenzie says that when two people apply for joint financing, lenders are required to use the lower credit score.
“So if one person has a 780 score and the co-borrower has a 690 score, the lower [score] is used to calculate the [interest] rate,” MacKenzie adds.
The solution? Freeman says the spouse with the higher score can apply for a mortgage loan on their own to avoid the problem, as long as they meet the income and other lender requirements. And don’t worry about leaving your spouse out: Freeman explains you can add your spouse’s name to the deed after the mortgage settlement has been completed.