If you’re thinking about buying a home or are in the early stages of property searching, it’s worth taking a look at your credit score.
Many financial institutions and lenders use your credit score, and more specifically your FICO score, to determine whether you are a good candidate for a home mortgage loan.
Other non-financial institutions also use your FICO score when considering you for a new contract, such as cell phone carriers or car insurance, so having a solid FICO score will always benefit your financial situation.
While your credit score doesn’t tell potential lenders everything about your finances, it influences two key areas when it comes to getting a home loan — risk and terms.
- Risk refers to how likely lenders will consider you to repay what they lend you. Because lenders are potentially at risk every time they lend money in the form of a mortgage, it’s important that they feel the person they’re lending the money to is responsible and will repay the total amount on time. Your credit history, whether you’ve historically paid your bills in full and on time, impacts your credit score.
- Terms refer to the conditions of your home mortgage. If your credit score is less favorable, potential lenders could view that as more of a risk than someone with a higher credit score, which can mean higher interest rates. The better your credit score, the greater your chances of being approved for a home mortgage loan, and the more favorable terms, such as interest rates, you can qualify for.
How Is Your Credit Score Calculated?
Financial institutions, banks, and other lenders look at credit scores to evaluate whether they want to lend money to someone.
Credit scores range from 300 on the low end to a perfect high-end score of 850 points and fall into four main groupings:
- excellent (scores between 740 and 850)
- good (scores between 700 and 739)
- average (scores between 640 and 699)
- bad or poor credit (scores below 639)
Most lenders prefer excellent and good scores over poor or bad credit scores.
To calculate your credit score, financial reporting agencies like Equifax, Experian, and TransUnion look at several areas of your credit history, each area accounting for a portion of your overall credit score. These areas include the following:
- Payment history (whether you pay your bill in full and on time): up to 35%
- Your total debt (the total amount of much money you currently owe): up to 30%
- The length of time you’ve had credit: up to 15%
- The amount of new credit you have (including credit cards): up to 10%
- What type of credit you use (credit cards, lines of credit, etc.): up to 10%
You can get one free copy of your credit score through each of the three reporting agencies, per year.
How a Low Credit Score Could Impact Your Ability to Buy a Home
While your credit score can impact your ability to buy a home, it isn’t the only factor lenders consider. There isn’t a firm rule that a credit score above a certain number is always approved or below a certain number is always denied. That’s because financial lenders consider many factors when deciding whether someone qualifies for a home loan mortgage.
Other factors lenders will be interested in include:
- How will you pay back the loan? Do you have a steady income source? Are you permanently employed? Are you an active, former, or retired military service member?
- Do you have a downpayment? Not every home mortgage loan requires a downpayment. Specific loan programs, like the VA loan, do not require borrowers to have a downpayment. Other loan programs, such as the FHA home loan program, require a reduced down payment for as little as 3.5% of the home’s purchase price.
- What is your income to debt ratio? It’s not just how much you owe or how much you earn; it’s both. Lenders look at how much you owe compared to how much you owe. If you earn $40,000 annually and owe less than $1,000, your debt-to-income ratio is low. However, if you earn $40,000 annually but owe more than $20,000, your debt-to-income ratio is considered high.
How a High Credit Score Could Lower the Interest Rate You Pay
If you’re buying your first home or are new to the homebuying process, you may not be aware of the relationship between your credit score and the interest rates attached to your mortgage.
It doesn’t take a massive jump in your credit score to generate a significant interest rate reduction. The difference of just a few interest rate points could add up to significant savings over the lifetime of your mortgage loan.
To see for yourself, check out the mortgage calculator below and see how even a few interest rate points can affect how much interest you can expect to pay.
What Credit Score Do I Need To Get A Mortgage?
While different mortgage products carry different credit score requirements, and your licensed mortgage lender can go over all the options you have available, there are some general guidelines:
- Federal Housing Authority (FHA) and Veteran’s Affairs’ backed loans having some of the lowest credit score requirements of around 580 points
- Most conventional home loans have minimum credit score requirements of 620
- And a credit score above 700 will help you avoid high-interest rates
Moving From Good Credit To Excellent Can Still Save You Money
Why pay more for a monthly mortgage payment if you don’t have to? Bumping your already good credit score up to excellent can translate into money in your bank with little added effort or inconvenience. Here’s how you can help to raise your score:
- Pay all your bills in full and on time. When you pay all of your debts–credit cards, student loans, car loans, utilities, rent, etc., on or before the due date, you’re doing good things for your credit score. The longer you do that, the better your credit rating becomes.
- Carry less than 30% on credit cards. If you plan to carry a credit card balance from month to month, keeping it below 30% of the card’s credit limit is good for your credit score. In other words, if you have a $10,000 credit card limit, aim to keep spending below $3,000).
- Don’t cancel zero-balance cards or accounts. Now that your debt has been eliminated, you might be thinking about canceling your cards, but keeping them around with a zero balance is a step in the right direction for a credit score bump. Having active, available credit but not using it sends a big positive message to potential lenders, letting them know that you are good at budgeting and managing your money and don’t spend more than you have.
If you are ready to buy a home but have questions about your credit score, or are curious about how credit affects what you can qualify for, reach out to the licensed loan officers at River City Mortgage.
Our experienced team will answer all of your questions about your credit score and buying a home, give the best recommendations based on your situation, and help you feel confident on your home buying journey.