Couples may be inclined to buy a new home together -- and, if necessary, apply for a home loan -- but new data suggest you ought to think twice before saying "I do" to joint mortgages. In fact, according to a note from the Federal Reserve, some borrowers could have saved a lot of money in interest if they'd applied solo.
"Specifically, we find that nearly 10% of prime borrowers who applied for their loans jointly could have lowered their mortgage interest rate at least one eighth of 1 percentage point if the mortgage was applied for by the applicant with a higher credit score and an income high enough to qualify for the mortgage," the note reads. "Furthermore, among the joint applicants with a lower credit score below 740, for whom mortgage interest rates are most sensitive to credit scores, more than 25% could have significantly reduced their borrowing cost by having the individual with a higher credit score apply."
How couples wind up overpaying
Good credit scores generally qualify you for the best terms and conditions on any type of financing, but mortgage borrowers are subject to what the Fed calls "the minimum FICO rule," FICO being a popular credit-scoring model. Per this rule, when two people apply for a mortgage together, only the lower of the two credit scores is considered in the underwriting and pricing of the loan by originators, mortgage insurers, and secondary market guarantors.
In other words, if you have a credit score of 740 but your sweetheart is saddled with a 650, you could wind up paying a much higher interest rate on a mortgage if you get one together. (You can see where you stand by viewing your two free credit scores, updated each month, on Credit.com.)
We use the term "could," because the rates and fees you pay on a mortgage can also be affected by your debt-to-income ratio. Borrowers generally need a 43% debt-to-income ratio to obtain a mortgage. So, if you need both your incomes to reach that threshold, applying together could give you more borrowing power.
It's worth doing some number-crunching before applying for loans, especially if you both need to be on the deed (not mortgage) to claim ownership of the home. Based on its analysis of over 600,000 joint-applicant securitized mortgages made from 2003 to 2015, the Fed estimates couples subject to the minimum FICO rule could have reduced their annual interest payment by $220 to $1,400 had they let the person with better credit apply solo.
How to get your credit mortgage-ready
Of course, it's a good idea to fix your credit (or have your spouse fix his or hers) before applying for a mortgage. You can generally improve credit scores by paying down high credit card balances, limiting inquiries during your home loan search, and disputing any errors on credit reports. (You may want to hire someone like a credit repair company if you're overwhelmed by the process or want to hit the "easy button.") You can also build good credit by making loan payments on time, keeping the amount of debt you owe below 30% and ideally at 10% of your available credit limit, and adding a mix of credit accounts over time.
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