A big part of getting approved for your home loan is your credit score. Buyers need to understand what to look for as they start the mortgage approval process.
Lenders will be referencing your credit score to determine the lending amount you qualify for, as well as the details of your loan. Buyers with high credit scores typically have access to preferable loan terms, such as lower interest rates or the waiving of fees such as PMI. Buyers can benefit from understanding the correlation between their credit scores and their home loans before they begin applying for mortgages to guide their loan shopping process.
Here is an overview of everything that buyers should know about credit scores and how they impact home loans.
What Is a Credit Score and Who Calculates It?
A credit score is a three-digit number that tells lenders how well you pay off the debts you have borrowed. Credit scores range from 300 to 850, with 300 being poor and 850 being the highest.
Lenders mitigate the risks associated with lending by using a credit score to gauge how a borrower will repay their loan. Lenders can use this information to gain insight on how long it will likely take you to pay back your loan, as well as how much you can afford to pay for the total loan. They take this information into consideration as they underwrite your mortgage offer, which shapes the characteristics of your loan.
Three of the biggest credit bureaus that track and monitor your credit are Equifax, TransUnion, and Experian. There are multiple types of credit scores, such as FICO and Vantage scores. Each ranking system uses a different protocol to determine the credit score, so people typically have different scores.
Today, 90% of top lenders use the FICO score to determine a borrower’s creditworthiness. Buyers approaching a mortgage should focus on their FICO score as it is the standard maintained by most lenders. A FICO score is ranked as follows:
- 300 to 569: Very Poor
- 570 to 669: Fair
- 670 to 739: Good
- 740 to 799: Very Good
- 800 to 850: Excellent
Lenders choose the FICO score because it is one of the most reliable and strict credit score models.
How Are Scores Calculated?
Your credit score is updated every time either you or a creditor checks your credit account. A credit score is determined by a combination of your personal financial information. The items that are reviewed to shape your credit score are your payment history at 35%, credit utilization at 30%, length of credit history at 15%, mix of credit at 10%, and new credit at 10%. These five factors are combined to calculate your individual credit score.
Where Can You Find Your Credit Score?
Buyers can access their credit scores through a variety of resources. For a free check on your credit score, you can visit AnnualCreditReport.com. This website is a government-sanctioned resource where people can access one free credit check every year.
If you want to access your FICO score, you will need to go through your bank or financial institution. You can receive a free report on your FICO score through the FICO open access program. Depending on your bank, you may even be able to access your FICO score from your bank’s mobile app. If you try to get your FICO score without going through a financial institution, you may have to pay for an authorized retailer to run a credit check on you.
Buyers should be wary of finding their free credit scores online. Those resources typically show you the Vantage Score, which is different from the FICO score numbers being pulled by your lender. Buyers should seek the most accurate projection of their score to gain a clear understanding of their credit score and its impact on their ability to borrow a mortgage.
Can You Buy a Home with Poor Credit?
While it is possible to buy a home with poor or no credit, it will likely be more expensive and potentially more difficult to do so. Since the borrower’s credit score directly impacts their loan eligibility and offerings, low scores or no credit history may limit their ability to get approved for a loan.
Poor Credit Scores Typically Lead to Increased Interest
Borrowers with poor credit that are approved for their loans may end up paying thousands in interest due to a higher rate on their loan. Over the lifetime of a 30-year mortgage, small differences in percent can add up.
For example, a $250,000 with a 3.125% interest rate incurs $108,433 in interest over the life of the loan. The same $250,000 loan with an interest rate of 3% incurs a total of $103,557 in interest. The 0.125% change in interest costs the home buyer upwards of $5,000 in total.
Loan Options for Low or No Credit
However, there are plenty of systems in place to help aspiring buyers with poor credit take out a loan to purchase a home.
Lending institutions, such as the FDA and VA, offer special mortgage packages to assist borrowers with low or no credit. FHA loans accept credit scores of as low as 500. VA loans do not technically have a minimum score, but lenders typically seek a 620 minimum. USDA loans require a credit minimum of 640.
Compared to conventional loans which maintain basic standards of 700 credit scores, these alternative loan options give borrowers with poor or no credit the ability to take out a mortgage and purchase a home.
Additional Fees to Look Out For
While these loans do make funding accessible, it's important to consider that these loans do invite fees and additional costs that are not always included in conventional loans. For example, FHA loans require private mortgage insurance policies which charge upfront and annual premium amounts. Buyers in these situations should factor these expenses into the total costs of their loans.
5 Tips for Maintaining and Building Credit for a Home Loan
Here are five simple tips that buyers can use to help maintain and build up their credit as they are preparing to apply for their mortgage.
- Avoid taking on new debt when preparing to apply for your home loan.
- Make an effort to pay all of your bills on time and avoid late payments.
- Continue monitoring your credit score.
- Pay attention to your credit utilization rate, which is how much of your credit line is being used. Experts recommend only using 30% of your credit limit to avoid reducing your credit score.
- Check your credit report for any errors that may be negatively affecting your score. If you do find any mistakes on your credit report, contact your trusted financial professional to move toward addressing the issue.
For more specific information and guidance about your credit score and how to improve it, speak with a trusted financial advisor.
If you’re ready to begin shopping for homes for sale all over the U.S., browse through available listings with HomeFinder today.