Are you thinking about buying your own home but worried about your credit score? When buying a house, you’re going to need to meet a whole range of requirements.
One of the most important things about you, according to lenders, is your credit score. This shows them your credit history, so they can make a decision about whether to lend to you.
What kind of credit score do you need to qualify for a home loan? Does it need to be exceptionally high?
Here’s everything you need to know about credit scores, and how they affect your home loan application.
Table of Contents
How Your Credit Score Is Determined
Your credit score is a reflection of your credit history. It’s influenced by how you’ve used credit in the past.
There are several things that will affect your credit history. These include:
Payment history
This is arguably the most important part of your credit score. It takes into account whether you’ve paid your accounts consistently, and on time.
This also takes into account issues such as delinquencies, collections, and bankruptcies. This will include the size of the problem, how long it took to resolve them, and how long ago they were.
The more issues there are with payment in your account, the lower your score will be.
Amount owed
Next, your credit score takes into account how much you owe, in line with the current maximum credit you have.
It’s typically seen as a red flag if you’re using the maximum amount of credit that you have available to you. This is seen as a risk, and so it will lower your score.
Usually, anyone who is using below 30% of their credit is considered to be a safe bet to lend to.
The number of different accounts you hold, and the types of accounts, will also have an effect on your credit score. If you have a large amount of debt from many different sources, that’s going to reflect badly on your score.
Length of credit history
How long have you been using credit? In general, the longer you have been doing so, the better.
Of course, your accounts need to be in good standing, for this to reflect well on your account. If they are, it’s going to end in a good credit score.
A lender is more likely to lend to a borrower with 20 years of good credit, rather than someone who has 2 years of good credit.
New credit applications
Every time you apply for a new line of credit, that application will be reflected on your credit history. That happens even if you’re turned down for credit.
This is why it’s always a good idea to really consider opening a new line of credit before you do so. You should only do it if you really need to do so.
If you keep making applications, that will ding your credit history, so be aware of this.
Credit mix
We touched on this earlier, but a good mix of credit is something lenders like to see when they’re checking your credit history.
This should include revolving credit, such as credit cards, retail store cards, gas station cards, and so on. It should also include installment credit, which includes student loans, auto loans, mortgages and so on.
Your credit report won’t show any other information, such as your age, income, or length of employment.
The Minimum Credit Score Needed To Qualify For A Home Loan
Now you know what your credit score takes into account, you need to know how high it should be for a home loan. The short answer is, it depends on what kind of loan you want.
In general, the higher your credit score is, the better. With most conventional loans, a credit score of 620 or higher, you’ll be able to get the best home loan interest rates.
If you have a lower credit score though, that doesn’t mean that you can’t get a loan. There are some loans out there that require you to have a credit score of just 500, so you have options.
There are other home loans out there that will require you to have a higher credit score. For example, if you’re taking out a jumbo loan, you’re taking out a loan that’s outside of the maximum agreed limits.
Because of this, the loan is considered to be high risk. That’s why lenders want to issue these loans to people with credit scores of 700 or higher.
Range of mortgages
One of the most important reasons to have a good credit score is choice. When you have a great score, there will be several different loans that you can choose from.
That makes the market much more competitive for you as a borrower. You’ll be able to get the loan that gives you the best deal.
If you have a lower credit score, you can still get a home loan. However, you will not have as much choice.
This means you may have to go with a loan that isn’t as competitive. You can make adjustments, such as refinancing, later down the line though.
Credit score and mortgage rates
Your credit score will play a role in the interest rate and payment terms on your loan. If you have a good credit score, you’re more likely to have favorable terms.
This is because you’re judged more likely to make payments on time, and you’ll be less of a risk to lend to. If your credit score is lower, then you’re considered to be more of a risk.
Of course, this isn’t the only thing lenders look at when they’re calculating their mortgage offer. However, it is one of the more important ones, so it’s best to try and have a good credit score when you start shopping around.
Home Loans For Those With Low Credit Scores
Can you still get a home loan with a bad credit score? As you’ve seen above, there are some options out there for you, so you’re not automatically cut out of the market.
If your score is in the 500s, then you can actually qualify for a government-backed loan. These loans are designed to be backed by a government body, giving lenders the guarantee they need to lend to you without risk.
The idea is that if you were to default on your loan, then the government would cover the amount owed. These loans usually include Mortgage Insurance Payments, or MIPS, which you pay as insurance to the lender against you defaulting on the loan.
There are several options out there, so you can find a loan that suits you here:
FHA loan
These loans are backed by the Federal Housing Administration and were set up to allow more people to become homeowners. To qualify for this loan, you need a credit score of at least 500, although 580 will be better for you.
The benefit of these loans is that you can make a much smaller down payment. If you have a credit score of 580 or above, you can pay down as little as 3.5%, and secure the loan.
If you have a score of 5% or above, then you can get a loan, but you’ll need to put down a deposit of 10% or more. That deposit can be made using a gift from a friend or family member, savings, or a grant for down payment assistance.
USDA loan
These loans are backed by the US Department of Agriculture, and helps buyers looking to buy in rural areas. They’re a zero-down loan, and so you won’t need to have a down payment ready in order to qualify for it.
Typically, you will need a credit score of 640 in order to qualify for a USDA loan. If your credit score is lower, then the loan will need manual underwriting.
VA loans
These loans are backed by the US Department of Veterans Affairs and are designed with active service people, veterans, and surviving spouses in mind. Typically, you’ll need a credit score between 580 and 620 in order to qualify for one.
You don’t have to be a first-time buyer in order to get this loan, so as long as you fit in the categories above, you should be eligible.
Again, there’s no down payment required with these loans, and there are limited closing costs.
These are a few of the loans that are available to you, should you have a lower credit score. It shows that even if you have a lower score, homeownership is not out of reach.
How To Improve Your Credit Score
So you’ve checked out your credit score, and it’s not as good as you were hoping. You could take out a loan designed for you, but you want more choice.
In this case, you’ll want to work on your credit score and improve it, before you start shopping around. If you have time to do this, it’s a very good option.
You’ll be able to work on your credit score, making yourself more valuable as a borrower to lenders out there. You’ll have more choices when it comes to loans, so you can get the best deal.
Here are some ways you can improve your credit score, and help yourself get the best rates on your home loan:
Check your score for inaccuracies
The very first thing you should do is check your credit score. What is it currently?
This will give you a basis to work from. Take a look at the transactions on your credit score, to ensure that they are all correct.
If there’s anything incorrect on your credit score, that can affect it. This can include things like lines of credit still being open, or even fraudulent use of your credit.
If you see any issues, have them corrected as soon as you can. When you do, you’ll see your score will improve.
Get a handle on payments
On-time payments are crucial to getting a high score, so you’ll want to ensure all your payments are on time. Set up a system now, to ensure you never miss a payment.
It’s a good idea to set up a filing system, and have alerts for due dates. That way, you can’t forget about payment.
There’s also the option of automating payments. This allows you to have payments leave your account on a certain date, so you don’t have to do it manually.
Aim for 30% or less
As you saw earlier, it’s better to use 30% or less of your credit. If you’re using more, aim to bring that percentage down.
You can do this by paying off your bills in full each month. That will help reduce how much credit you’re using and reduce that percentage.
You can also ask for a credit limit increase, which will help you get to that 30% goal. However, you don’t want to start using more credit just because you have it.
Use ‘soft searches’
The more you apply for credit, the harder it will ding your credit score. You can limit this by doing ‘soft searches’ instead.
A soft search is one that’s not going to affect your score. These include checking your own credit score, checks done by institutions where you already do business, and credit card companies that check your file to see if they want to send you a pre-approved credit offer.
Make the most of a thin credit file
You may not have a large credit history, which will affect you when you’re looking for a home loan. You can use several tools that help you bulk it out, though.
There are tools that ‘boost’ the file, such as Experian Boost. This uses financial data that isn’t usually in your credit report, such as banking history and utility payments, to help calculate your score.
You can also get credit for on-time rent payments too, using specified services.
No matter what your credit score looks like, there is a home loan out there for you. Check your score, and see what you can apply for.
