Buying a home is one of the most significant investments you’ll ever make, and it’s important to understand all the factors involved to make the best decision for your family.
The housing market is constantly changing, so staying up-to-date on what you need to do to buy a house is essential. There are many different types of lenders and loan programs available, and it can take time to know which one is right for you.
This article will help you understand what a good credit score is for buying a house and how that score is determined. We’ll also explain the different types of lenders and loan programs available, so you can make an informed decision about which one is right for you.
How Credit Scores Work
Knowing your credit score is essential when obtaining a mortgage, so let’s take an in-depth look at this vital factor and what lenders are mainly concerned with.
If you are seeking to borrow money, your credit score is a vital factor for lenders when determining their risk. Credit scores measure how well a person has managed their debts and financial obligations over time, ranging from 300 (low) to 850 (high).
A strong credit score indicates that you have taken care of past loan payments and show responsibility in managing finances. Credit scores vary between credit bureaus; the three major credit rating agencies are Equifax®, Experian™, and TransUnion®.
Your credit score is a good indicator of whether you are a responsible borrower, which determines your loan terms. A high credit score is an excellent indicator of your creditworthiness, while a low credit rating shows you could be trouble repaying the loan:
- 850 – 800 = Excellent. It’s the highest range, indicating the borrower is low-risk. Individuals within this range have the easiest time accessing credit and usually get the best terms, like low-interest rates and access to higher loan amounts.
- 799 – 740 = Very Good. It also indicates that one is a low-risk borrower. It’s easy to access credit when in this range. You will also get good mortgage rates.
- 739 – 670 = Good. Borrowers falling within this range are viewed as lower-risk, making it easier for them to obtain good terms. However, payment terms for borrowers in the higher ranges will still be superior compared to those in this range.
- 669 – 580 = Fair. If you are in this range, lenders consider you a high-risk borrower. A score in this range makes it harder to access credit. If you get credit from any lender, the terms will not be as friendly as those in the above ranges.
- 579 – 300 = Poor. By having a score that is below Fair, you will be viewed as an even higher-risk borrower than those with scores above it. Obtaining credit may become more difficult, and the interest rates or monthly payments offered to you can be very high due to this increased risk level.
What Mortgage Lenders Look for In Credit Scores
While the ratings may vary, the factors affecting a score do not. Most bureaus use two scoring models, FICO Score and VantageScore models. Regardless of the scoring model used, all rating agencies consider the following factors when reviewing a mortgage application:
Payment History
Lenders want to see how much you borrowed in the past and whether you repaid the money on time. Did you have late or missed payments? Do you have a bankruptcy, lien, or judgment records? Does your record have delinquent accounts? A credit report history mangled with late or missed payments, delinquents, bankruptcy, or judgments leads to negative points, lowering your credit score.
Employment History
Lenders also pay attention to a borrower’s employment history, as this can indicate their ability and willingness to repay the loan. If a borrower has had multiple jobs in recent years, this could be seen as an indication that they may have difficulty providing a steady income for repaying the loan. A history of job hopping or frequent layoffs could negatively affect their credit score.
Additionally, lenders may consider the stability of your current job and whether it is enough to cover your existing debt obligations and future mortgage payments. This means that individuals who are self-employed or work on a contract will likely face greater scrutiny when applying for a mortgage than someone with stable full-time employment.
Credit Utilization
Credit utilization is a percentage of how much credit you use based on your limit. Rating agencies determine this figure by dividing your total debt by the total credit limit. A high credit utilization lowers your credit score. That’s why keeping credit card balances low is important to ensure your utilization remains low. Low balances show lenders that you are not constantly maxing out your credit.
Credit Length History
Developing a long credit history is an excellent way to demonstrate your ability to manage debt. There are several key components here, such as the age of your oldest and most recent credits, the mean age of all accounts on file, and whether you’re actively utilizing any current credit account.
For instance, new accounts lower the average age of all your accounts, lowering your credit score. Closing older accounts might take time to affect your credit score since they remain in your report for ten years. However, once they are removed from your report, it is a different story altogether because it lowers your average account age and credit score.
Type of Debt in Your Report
Having different credit types available in your report is essential, and having a mix of revolving and installment debt is ideal. For example, you could obtain a credit card, personal, or student loan. Doing so will demonstrate to prospective lenders that you can handle various debts responsibly.
Applying for New Credit
It’s not just the amount of money borrowed or the limit of new credit cards. New credit lines lead to hard inquiries. Hard inquiries or hard pulls happen when lenders run your credit report. These create a slight but temporary dip in your credit rating.
The more credit lines you open within the same period, the more hard inquiries your report has, lowering your score further. This is because rating agencies assume that individuals apply for several credits simultaneously when they are experiencing cash problems or personal finance issues and are thus a high risk.
Comparing Various Home Loan Programs
As previously mentioned, lenders consider your credit score when you apply for loans, including a mortgage or a refinance. While lenders prefer a high credit score, you can still get a mortgage with a low credit score, even if you are a first-time home buyer. It all depends on the type of mortgage loan you are applying for. Comparing the options below allows you to consider your options and choose one that suits your situation.
Conventional Loan
These mortgages do not have any backing from the government. Instead, they follow standards set forth by Fannie Mae and Freddie Mac. Conventional mortgages are ideal for individuals with higher credit scores, usually 620 and above, and high down payment. You can still apply for a mortgage with a lower credit score, but you will likely receive a higher interest rate when approved.
FHA Loan
The Federal Housing Administration backs FHA loans for home buyers with low credit scores and down payment. The minimum required credit score is over 580 and a 3.5% down payment. That said, some lenders extend mortgages to individuals within the credit score range of 500 to 579 and a 10% down payment.
VA Loan
VA loans are a type of government-backed mortgage loan. The U.S. Department of Veterans Affairs backs them for veterans, active-duty members, and eligible spouses. Although there are no industry-set minimum credit score requirements for VA loans, lenders have set their own limits. Most lenders offering this type of loan usually have a minimum credit score requirement of 580 to 640. Additionally, there is no required down payment, and they often have lower interest rates than other mortgage loans.
USDA Loan
The U.S. Department of Agriculture backs USDA loans for homebuyers in eligible rural or suburban areas. While there is no set minimum score by the department, lenders can have their scores, usually ranging from 580 to 640.
Jumbo Loan
Jumbo mortgages – also referred to as non-conforming loans – are for home buyers seeking mortgage amounts exceeding limits set by Federal Housing Finance Agency (FHFA). They have stricter requirements, like higher credit scores, down payments, set debt-to-income ratio, and purchase of specific properties. The minimum credit score varies, but most lenders require 640 and above.
How Can You Improve Your Credit Score?
Do you have a bad credit score and cannot qualify for the mortgage loan you want? There is no need to panic and give up. There are several ways to improve your credit score and buy your dream house. Here’s how you can go about it:
- Paying bills on time – these affect your repayment history, which accounts for the largest portion of credit scoring
- Paying off outstanding debt – helps you make room for more credit and improves your credit utilization. Repaying these and maintaining low balances will significantly impact your credit utilization rate if you have credit cards.
- Checking your credit report for errors – it’s essential to check your report for any mistakes that might affect your score. You may have made a payment that needs to be captured correctly. Or someone stole your credit card information and used it for fraudulent transactions.
- Remember to get a free credit report yearly from the three major bureaus – You can take advantage of this every year to ensure that entries in your report are always correct.
- Keeping your credit cards open – even when repaid and you do not wish to use them again to manage your debt, closing your credit cards affects your score. It lowers your available credit limit and average credit score. You can maintain the credit card and charge it regularly with small amounts you can repay.
- Only apply for a few new credit lines at a time – although a mix of credit lines is important in building your creditworthiness, opening too many credit lines at once tanks your score because of the hard inquiries.
Closing thoughts on credit scores
Ultimately, the credit score requirement for purchasing a home depends on the loan type you are applying for. Nevertheless, having an excellent credit rating is essential to guarantee access to superior terms from lenders for any mortgage loan and affordable monthly mortgage payments.
If becoming a homeowner is your plan, start boosting that credit score ASAP. Take the time to review your history and be sure there are no mistakes; then look into more ways of improvement. With better terms, such as low-interest rates and budget-friendly payments, improved scores will give you an edge when applying for mortgages.
Finding the best real estate investment for you can be challenging if you don’t have perfect credit or funds for a large down payment. Investing through Arrived can help overcome these obstacles and the hassle of finding and managing properties. You can invest anywhere from $100 to tens of thousands per house and build a portfolio across several properties. Browse available properties today and see how your initial investment could grow over the next few years.
The opinions expressed in this article are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. The views reflected in the commentary are subject to change at any time without notice. View Arrived’s disclaimers.
