What’s your number? That’s not a pickup line; it’s what a lender will want to know. The number will range from 300 to 850, and it will weigh heavily in whether you qualify for a conventional or government-backed loan and at what interest rate.
The national average credit score has inched up in the past few years, all within the range considered “good.” But applicants with “fair” and even “poor” credit scores can and do secure mortgages.
Below, we’ll cover the minimum credit score for a mortgage and how you can improve your credit score if needed.
First, Why Does a Credit Score Matter So Much?
Lenders look at a credit score to help determine whether a potential borrower is trustworthy. Considering that the recent median home sale price was over $350,000 and that financial institutions hold about $10 trillion in mortgage debt, lenders want to know that a borrower is solid and that repayment will be made.
Credit scores were created by the Fair Isaac Corp. to put a simple numerical representation on a person’s history of obtaining and repaying debt.
There are now other institutions that also calculate credit scores, but FICO® scores are the most commonly used. Experian, Transunion, and Equifax are the three credit reporting agencies that collect information on your history of borrowing, and then FICO® or another company amalgamates the information into a score between 300 and 850.
In general, those with a strong history of making on-time payments on their debts will have higher credit scores. Here’s what goes into calculating a credit score:
• Payment history (35%): Considers whether the applicant has made payments on time.
• Credit utilization (30%): The ratio of how much you could borrow from all accounts vs. how much you are borrowing. The lower your credit utilization, the better.
• Length of credit history (15%): Histories with accounts that have been open for longer are seen more favorably than those that have been open for less time.
• Types of credit (10%): Having multiple types of debt is preferable. Installment credit, such as an auto loan, personal loan, student loan or mortgage loan, and revolving credit, like a credit card, are both considered.
• New inquiries (10%): Each time a new inquiry on credit is made, there can be a negative effect on a credit score. Credit inquiries happen when opening credit cards and taking out loans, and even when a lender does a “hard pull” on your credit history.
A Look at the Numbers
Here’s how credit scores are generally classified:
• Exceptional: 800-850
• Very good: 740-799
• Good: 670-739
• Fair: 580-669
• Very poor: 300-579
In general, lenders consider applicants with “bad” or “poor” credit score subprime borrowers. Depending on what type of mortgage loan an applicant is trying to acquire, it may be hard to obtain a loan with a credit score lower than around 600.
If you are trying to acquire a conventional loan, you’ll likely need a credit score of at least 620.
With an FHA loan, 580 is the minimum credit score to qualify for the 3.5% down payment advantage. Applicants with a score as low as 500 will have to put down 10%.
The FHA program was created to get applicants with lower credit scores into homes. The loans are insured by the Federal Housing Administration, so lenders are more lenient.
A VA loan usually requires a minimum score of 580 to 620; and a USDA loan, 640.
Credit Scores Are Just Part of the Pie
Credit scores aren’t the only factor that lenders consider when reviewing a mortgage application. They will also require information on your employment, income, and bank accounts. A lender facing someone with a low credit score may increase expectations in other areas like size of the down payment or income requirements.
The lowest credit scores that lenders are willing to accept change with the economic environment. During the housing crisis of 2008 and the years after, it was very difficult for borrowers with credit scores lower than 700 to obtain loans.
During better economic times, credit score requirements for borrowers may loosen. Therefore, it is a bit of a moving target to nail down the precise average or the lowest possible credit score one must have to receive a mortgage loan.
How to Bump Up a Credit Score
Working to improve a credit score before applying for a home loan could save a borrower a lot of money in interest over time. Lower rates will keep monthly payments lower or even provide the ability to pay back the loan faster.
Let’s look at an example using a mortgage calculator: If you were take out a mortgage on a $400,000 home after putting 10% down with a 4.5% interest rate on a 30-year fixed rate mortgage, your monthly payment would be $1,824 and you would pay $296,663 total in interest over the life of the loan.
If you were to take out that same loan with a 5.5% rate of interest, your monthly payment would be $2,044 and you’d pay $375,854 total in interest. The difference of 1% in interest results in almost $80,000 paid over time.
Improving your credit score will take a bit of time, but it can be done. Here’s how:
1. Check for errors on your credit report. Reporting errors are quite common, so be certain that your credit history doesn’t mistake a missed payment or report a debt that’s not yours. You can get a free credit report once a year from each of the three reporting agencies: Transunion, Experian, and Equifax.
2. Pay all of your bills on time. If you haven’t been doing so, it could take up to six months of on-time payments to see a significant improvement.
3. If you do not have credit established, an easy way to do so is by opening a credit card. But only do this if you are prepared to use the credit card responsibly. This means paying back the card, in full, each month. Do not simply pay the minimum payments. If you are having trouble qualifying for a card, look into a secured credit card. With a secured card, you put a cash payment down that works as your line of credit, proving you can manage a credit card.
4. Request to increase the credit limit on one or all of your credit cards. This will increase your credit utilization ratio by showing that you have lots of available credit that you don’t use. It is best to keep the credit utilization ratio below 30%, meaning you’re only using 30% of your available credit at any time.
Understand that this number can be assessed at any time during the month, not just on the day that you pay your bills. Even if you pay your cards in full every month, if you’re consistently using more than 30% of your available limit, you could get dinged.
5. If you are working to pay off credit cards, don’t close them once you’ve paid them off. Keep them open by charging a few items to the cards every month (and paying them back). Remember, sources of debt that have been in use for longer are preferable to ones that are new. For example, if you have two credit cards, each has a credit limit of $5,000, and you have a $2,000 balance on each, you currently have a 40% credit utilization ratio. If you were to pay one of the two cards off and keep it open, your credit utilization would drop to 20%.
6. Consider obtaining a personal loan. If you have multiple credit cards and are struggling to manage them and pay them off, this might be a good solution. A personal loan may have a lower rate.
Another option for those with lower credit scores is to have a co-signer on a mortgage loan. If this person has a better credit score and financial situation than the main applicant, it could greatly improve the rate that a lender will offer. Only go down this route if this is a relationship that you can trust completely.
Once you feel that your credit score is ready, be sure to shop around for a home loan at several lenders. You want to be sure that you’re getting the best rate given your personal financial situation, and not every lender has the same criteria.
Know that even with credit scores that aren’t perfect, there are options for people who want to be homeowners; it’s just a matter of seeking out those options.
What credit score is needed to buy a house? The numbers hinge on the economic climate, lender and type of loan, but those with imperfect credit often manage to secure home loans. First, know your credit score, take time to improve it if needed, and compare lender offers.
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