Here’s Why You Should Aim For A Higher Credit Score For A Home Loan
Just because you can qualify for a conventional mortgage with a 620 FICO® Score, or an FHA loan with a FICO® Score in the 500s, doesn’t mean it’s the best idea. FHA loans are expensive in general, and conventional lenders base your mortgage’s interest rate on your FICO® Score, among other factors. With a low FICO® Score, you could end up paying tens of thousands of dollars in additional interest on your loan, relative to a top-tier borrower.
Let’s put some numbers behind this. Zillow’s latest data puts the median home value in the United States at about $260,000. A 20% down payment , would imply a mortgage amount of $208,000. Here’s what type of mortgage payment this could translate to on a 30-year fixed-rate conventional mortgage. We’ve based our calculations on the latest average rates by credit score for a home loan:
FICO® Score Range |
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Matt is a Certified Financial Planner® and investment advisor based in Columbia, South Carolina. He writes personal finance and investment advice for The Ascent and its parent company The Motley Fool, with more than 4,500 published articles and a 2017 SABEW Best in Business award. Matt writes a weekly investment column that is syndicated in USA Today, and his work has been regularly featured on CNBC, Fox Business, MSN Money, and many other major outlets. Hes a graduate of the University of South Carolina and Nova Southeastern University, and holds a graduate certificate in financial planning from Florida State University.
How Does Credit Score Affect Refinance Rates
Your credit score doesnt just impact your refinance approval. It also affects the interest rate lenders will offer you. Everything else being equal, a high score should earn you a lower rate while a bad credit score means youll pay more for your refinance loan.
You can use FICOs loan savings tool to give you a rough idea of just how much your credit score affects your mortgage rate and monthly payment. In turn, this will have a big impact on your total interest cost over the life of the loan.
We show one example below using a 30-year, fixed-rate mortgage with a $400,000 loan amount.
$2,490 | $495,270 |
*Annual percentage rates reflect the nationwide average according to FICO.com on April 26, 2022. Interest rates change daily and rates shown here do not reflect the rate you will be offered.
Moneys Average Mortgage Rates For October 13 2022
Mortgage rates remain volatile. Borrowers looking for a 30-year fixed-rate loan can expect rates averaging 7.818%, 0.055 percentage points higher than yesterday.
Rates on adjustable-rate mortgages also continued to make big day-to-day changes. The 5/6 ARM is averaging 7.199%, an increase of 0.201 percentage points.
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The latest rate on a 30-year fixed-rate mortgage is 7.818%.
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The latest rate on a 15-year fixed-rate mortgage is 6.839%.
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The latest rate on a 5/6 ARM is 7.199%.
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The latest rate on a 7/6 ARM is 7.37%.
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The latest rate on a 10/6 ARM is 7.494%.
Moneys daily mortgage rates are a national average and reflect what a borrower with a 20% down payment, no points paid and a 700 credit score roughly the national average score might pay if he or she applied for a home loan right now. Each days rates are based on the average rate 8,000 lenders offered to applicants the previous business day. Your individual rate will vary depending on your location, lender and financial details.
These rates are different from Freddie Macs rates, which represent a weekly average based on a survey of quoted rates offered to borrowers with strong credit, a 20% down payment and discounts for points paid.
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Whats A Good Credit Score To Buy A House
Most lenders require a 740 credit score or higher to qualify for the lowest mortgage interest rates, so anything above 740 is considered a very good score to buy a house. Armed with this score, you can secure a more affordable monthly payment and have more buying power when making purchase offers. Lenders often reward high-credit-score borrowers with fewer documentation requirements, a smoother approval process and exceptions for high debt-to-income ratios.
That doesnt mean you cant get a mortgage with a score below 740. Most standard home loan programs require you to meet minimum credit score requirements, which range from 500 to 620.
THINGS YOU SHOULD KNOW
There are several types of credit scoring formulas, but most lenders use the FICO scoring system. The FICO Score is calculated using an algorithm based on your payment history, how you manage credit and the mix of different accounts you have.
Once Your Home Loan Gets Started
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If you get approved for a VA mortgage or a VA Cash-Out Refinance Loan, be prepared to have your credit run at least a second time by the lender during the course of the loan process. If your FICO scores change between loan approval and loan closing, your lender may be required to re-qualify you if the scores decline too much. That is one reason why borrowers are urged to completely avoid applying for other lines of credit during the home loan approval process and all the way up to closing day.
Your lender can and likely will run your credit more than once. Dont let a bad assumption derail your mortgage loan stay away from all new credit applications until after closing day. Youll be glad you did.
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Increase Your Available Credit
Another thing lenders look at when assessing a borrowers creditworthiness is their credit utilization ratio. This ratio compares the borrowers debt, particularly credit card debt, to their overall credit limits.
For example, if you have one credit card with a $2,000 balance and a $4,000 credit limit, your credit utilization would be 50%. Lenders look for borrowers with lower credit utilization because maxing out credit cards can be a sign of default risk.
A credit utilization of 30% is good, but less than 10% is better. So if you have a card with a $1,000 credit limit, to optimize your credit score youll want no more than $100 outstanding on the statement date for the card.
That means that one of the easiest ways to boost your credit score is to decrease your credit utilization ratio. You can do this by paying down debt or increasing your credit limits.
If youve had a credit card for a while and have built a good payment history, most card issuers will be willing to offer a credit limit increase. You can typically request an increase through your online account.
Theres no risk when requesting a credit limit increase. The worst a lender can do is say no, leaving you exactly where you started. In the best-case scenario, youll get a big credit limit increase, dropping your credit utilization ratio and giving your credit score an immediate boost.
Determining A Qualifying Credit Score
Before we get into the credit score you need to qualify, you might be wondering how lenders determine your credit score. After all, your FICO® Score is reported by three different bureaus.
If you’re applying for a loan on your own, lenders get your from each of the three major credit rating agencies and use the middle or median score to qualify you.
If there are two or more borrowers on a loan, the lowest median score among all clients on the mortgage is generally considered the qualifying score. The exception to this is a conventional mortgage with multiple clients being backed by Fannie Mae. In that case, they average the median scores of the borrowers on the loan.
If you have a median score of 580 and your co-borrower has a 720 credit score, the average credit score would be 650. Because the minimum qualifying score for conventional loans is 620, this can mean the difference between qualifying for a mortgage and not.
One thing you should know is that for the purposes of your rate and mortgage insurance, the lowest median score is the one that gets reported, so your rate might be slightly higher. There are also certain situations in which Fannie Mae still uses the lowest middle score for qualification. We recommend speaking with a Home Loan Expert.
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How Your Credit Score Affects Mortgage Rates
Your plays a role in determining the interest rate and payment terms on a mortgage loan. That’s because lenders use what’s called a risk-based pricing model to determine loan terms.
The more likely you are to pay your bills on time, based on your credit history, the lower your interest rate may be. With a less-than-stellar credit score, however, you may end up paying more.
What Credit Score Do I Need To Get A Mortgage
Several types of mortgage loans exist, and each one has its own minimum credit score requirement. Lenders may also have additional, stricter criteria they use to determine your creditworthiness other than your credit score .
Here’s what to expect based on the type of loan you’re applying for:
If your credit score is in great shape, you may have several different loan types from which to choose. But if your credit score is considered bad or fair, your options may be limited.
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Aim For A Score Of 740 Or Higher To Get The Best Rates On A Mortgage But Many Lenders Will Work With You If You Have A Score Of 670 Or Higher Pros Say
Looking to buy a home? Heres what you need to know about your credit score.
Lenders use your three-digit credit score as a way to predict how likely a borrower is to repay a loan like a mortgage on time. Higher scores signal a great likelihood of repaying a loan lower scores a lower likelihood. Lenders tend to give the best rates on home loans to those with a higher score, ideallly 740 and above, and the higher the better though other factors typically play into who gets the best rates, too.
What is a good credit score to get a home loan?
Generally speaking, a score of 740 or higher will help you get the best possible rate on your loan and make it easier to find a lender. That said, plenty of lenders could still be willing to work with you if your credit score is 670 or higher, says Jacob Channel, LendingTrees senior economic analyst.
Sara Rathner, personal finance expert at NerdWallet, notes that there are variations in what scores a lender wants, as there are different credit scoring models that lenders use to make decisions.
You may be able to get a loan with an even lower score: Depending on other factors like what your income is and how much debt you have, you can potentially qualify for a mortgage loan with a credit score as low as 500.
What is your credit score made up of?
Amount owed | 30% |
What are the various credit score levels?
Poor credit |
*Source: Experian
What is excellent credit vs. poor credit?
How can someone view their credit score?
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How Many Years Of Credit Do I Need To Have A Good Score
Mortgage lenders will typically look back over the last six years of your credit history. If youre young and only have a couple of years credit to examine, lenders may be more cautious to lend to you. However, theres no set timeframe that will automatically boost your credit score. A 25-year-old in regular, stable employment who uses their credit card sensibly could have a better credit score than a 50-year-old with lots of debts.
The key thing to remember here is that you dont just need years of credit to improve your score those years of credit have to be good credit. Bankruptcy, CCJs, IVAs and other bad marks will stay on your file for six years, so its highly likely youll need to wait for these to be wiped before being accepted for a mortgage.
Buying A House With A Credit
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The upside to buying a house with your spouse or partner is that youre likely combining two incomes, which can help you qualify for a larger mortgage payment and a more expensive home.
The downside is that one co-borrowers low credit score can tank the application for both borrowers. Thats because mortgage lenders use the lower credit score between the two applicants.
Before adding a co-borrower who has bad credit, use a mortgage calculator to see if you can qualify for the loan on your own. If your income is sufficient, you can leave your partner off the mortgage altogether.
You can always add your partner to the property title once the mortgage closes. However, doing this gives your partner some ownership interest in the property, while you would be the only one obligated to pay the mortgage.
Note that if you have joint bank and investment accounts, you can use this money for your down payment and count it as an asset on your mortgage application. Your partner will have to write a letter stating that you have access to 100 percent of the jointly held funds.
Money in accounts that are solely in your partners name wont be considered your assets under most program guidelines.
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Other Requirements To Buy A House
Theres more to know than just credit minimums. After all, underwriting guidelines comprise hundreds of pages.
In addition to credit scores, lenders evaluate borrowers based on:
- Down payment: Most loan programs require at least 3% down.
- Income and employment history: Most lenders want to see at least two years of steady income and employment
- Savings: Youll need cash to cover the down payment and closing costs sometimes youll need to have cash reserves left over after paying these costs
- Existing debts: Your debt-to-income ratio compares preexisting debts like student loans, auto loans, and credit card minimum payments against your monthly gross income. The lower your DTI, the better
The size of your loan also matters. When you have lower credit, your loan amount will likely need to stay within FHA loan limits or conforming loan limits.
How Can I Reduce My Chances Of Being Rejected For A Mortgage
As well as taking the steps above to build a strong credit history, there are other ways to get yourself in the best financial shape for a mortgage:
- Avoid applying for anything that requires a hard credit search at least 12 months before applying for a mortgage.
- Try and keep your credit use below 25%. This will show youre responsibly using things like a credit card or overdraft.
- Keep making credit payments on time. If youre having problems, contact your lender immediately and discuss other options that could help you avoid a negative mark on your credit record.
Once youve built up your credit score to the best level you can achieve, contact a mortgage broker so that they can find you the best available mortgage deal and interest rates.
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What Mortgage Lenders Look For When Approving A Home Loan
When you apply to get pre-approved, your lenders will review your credit history and consider your current credit outlook. This includes looking at:
- How on-time have you been with your payments and obligations?
- What does your current debt load look like, and how is it spread out?
- How much experience do you have managing credit?
- Have you been recently trying to acquire access to new sources of credit?
- Do you let items go into collections?
- Have you previously filed for bankruptcy?
Lenders ask these questions to get comfortable with you. Your financial health isnt the only consideration lenders make, but how you manage your bills tells a large part of your story.
Lenders also look for specific credit events known as derogatory items, like bankruptcy or delinquent accounts.
Derogatory items dont disqualify a mortgage approval. Generally, its only required that theyre historical events and not current ones. For example, you can get approved for a mortgage if youve declared bankruptcy in the past, or if youve lost a home due to foreclosure.
Lenders know that life is unexpected and bad things happen. Whats important is whats happened in the time since the derogatory event occurred.
Check Your Credit Score And Reports
Knowing where you stand is the first step to preparing your credit for a mortgage loan. You can check your credit score with Experian for free, and if it’s already in the 700s or higher, you may not need to make many changes before you apply for a preapproval.
But if your credit score is low enough that you risk getting approved with unfavorable terms or denied altogether, you’ll be better off waiting until you can make some improvements.
You can get a free copy of your credit report from Experian, which is updated every 30 days, or from each of the three national credit reporting agencies weekly at AnnualCreditReport.com through December 2022, then every 12 months after that.
Once you have your reports, read through them and watch for items you don’t recognize or you believe to be inaccurate. If you find any inaccuracies, you can ask your lender to update their information with the credit reporting agencies or dispute the items directly with the agencies. This process can improve your score quickly if it results in a negative item being removed.
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