You are ready to buy a home and think you know what you can afford, but do lenders agree? You may be on two different wavelengths if you don’t understand the connection between your FICO scores and home mortgages.
Your credit score is one of the first things lenders look at when you apply for a mortgage. Why? Your credit score tells lenders a lot about your financial life and how well you handle your money. The three-digit number speaks volumes.
A low credit score makes lenders think that you don’t pay your bills on time (or at all) or that you overextend yourself financially. A high credit score shows that you do pay your bills on time and handle your finances responsibly. Lenders prefer borrowers to have a high credit score as it lowers their risk of default.
Does a low credit score mean you won’t get a mortgage and does a high credit score mean you’ll get the highest loan amount and lowest interest rate?
It truly depends on a variety of factors, which we discuss below.
What is a Good Credit Score?
First, we should define a ‘good’ credit score. 90% of today’s top lenders look at your FICO score, even though there are other credit scoring models out there today.
The FICO credit scoring model uses the following range:
- Less than 580 – Poor
- 580 – 669 – Fair
- 670 – 739 – Good
- 740 – 799 – Very Good
- 800+ - Exceptional
While lenders would love it if all borrowers fell into the 800+ credit score range, they know that’s not feasible and most lenders are flexible with their guidelines.
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What are the Credit Score Requirements for Buying a House?
There isn’t a one-size-fits-all approach to credit score requirements when buying a house. Each loan program does have its minimum credit score requirements, but even within each program, there are exceptions.
In general, you need the following scores for each program:
- Conventional loans – 680 credit score
- FHA loans – 580 credit score
- VA loans – 620 credit score
- USDA loans – 640 credit score
But there may be situations where you have a lower credit score but have compensating factors that ‘make up’ for the lower score.
For example, if you have a 670 credit score, but you have exceptionally high income and little debt, a lender may approve you for a conventional loan. They use the credit score as a guide, but they also look at how well you can afford the loan. A borrower with high income and little debts will have a low debt-to-income ratio.
The debt ratio says a lot more about your ability to repay the loan than your credit score does, which is why it’s a ‘compensating factor’ because it makes up for the lower credit score.
Another example of a good compensating factor is a high down payment. If you have 20 percent or more to put down on a home, lenders may be able to overlook the ‘lower credit score.’
How do Credit Scores Affect Mortgage Rates?
While FICO scores affect your ability to get approved, they also affect your mortgage rates. The lower your credit score is, the higher the interest rate a lender may charge. Lenders base interest rates on your ability to repay the loan. The higher your risk of default, the higher the interest rates they charge.
While it may not seem like a huge difference, even a rate that’s 0.5% higher can have a drastic impact on your mortgage.
Let’s look at a $200,000 mortgage at varying credit score ranges to see the difference:
- 750 credit score at 3.029% = $846 principal and interest payment
- 700 credit score at 3.251% = $871 principal and interest payment
- 650 credit score at 4.072% = $963 principal and interest payment
Monthly, the difference between the 650 credit score rate and the 750 credit score rate is $117. Over the course of a year, though, you’d save $1,404 and over the term of the loan (30 years), you’d save $42,120 just for having a good credit score!
Can you get a Mortgage with a Low Credit Score?
Many lenders still provide mortgages with a low credit score, but you may face different terms.
- You may need a higher down payment
- You may pay a higher interest rate
- The lender may charge more/higher closing fees including origination points
- You may be able to borrow less
Even if you don’t meet the credit score guidelines noted above, you may qualify for a subprime mortgage from an alternate lender. Lenders write these loans and their guidelines themselves, which often gives you more flexible guidelines and a higher chance of securing a loan.
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Simple Tips to Boost Your Credit Score
If you don’t have a ‘good’ credit score or you want to maximize your chances of qualifying for the lowest interest rate and highest loan amount, by increasing your credit score, try the following tips:
- Get caught up on any late payments
- Pay your debt balances down so that you owe less than 30% of your credit lines
- Don’t apply for new credit in the months leading up to your mortgage application
- Don’t close old or unused credit cards
- Contact the credit bureaus to fix any errors or fraudulent activity
- Make sure you have a decent mix of revolving and installment credit
Your FICO score plays a vital role in your ability to secure a mortgage. It affects your ability to get approved, but it also affects the terms of the mortgage you can get. Each lender has different requirements, so don’t assume even if you have ‘bad’ credit that you can’t get a loan, but boosting your credit score in the months leading up to your mortgage application can have the best results.
At AWay Home Loans, we offer loans even to those individuals with a 'bad' credit score. If you want to see if you qualify for any of our mortgage loans, click here.