When it comes to qualifying for a mortgage, there are a lot of factors that lenders will look into to determine your eligibility. One of the most important factors is your credit score. Your credit score provides lenders with a somewhat broad idea of how financially responsible and how financially stable you are. A low credit score identifies you as a risk because it usually means that you had some issues taking on debt or paying your creditors on time or in full in the past.
Typical Minimum Credit Score By Mortgage Type
Because your credit score identifies the risk that you pose as a borrower, most lenders have strict requirements when it comes to the minimum credit scores that they will accept. However, the minimum credit scores can vary from lender to lender as well as based on the type of mortgage you’re taking out. The following is a brief rundown of the credit score requirements most lenders have in place for some of the more common types of home mortgages:
FHA Credit Score Requirements
Typically, FHA loans require a credit score of 580 or above. If your credit score is above 580, it means you only have to make a 3.5 percent down payment. There is an exception to this credit score minimum. If you have a credit score between 500 and 579, you can still qualify for an FHA loan, but you’ll have to make a down payment of 10 percent. However, you won’t find a minimum credit score requirement that’s lower than that of an FHA loan.
What Is an FHA Loan?
FHA loans are home mortgages that are backed by the Federal Housing Administration. This means that lenders are taking on less of a risk when they issue FHA loans to borrowers with lower credit scores since they are insured by the federal government in the event that the borrower defaults. As such, credit score requirements are much lower. Because of how low the down payment requirements are (not to mention the low credit score requirements), FHA loans are very popular with first-time homebuyers.
VA Loan Credit Score Requirements
VA loans, which is a home mortgage program established by the Department of Veterans Affairs to help veterans (or the surviving spouses of veterans who were killed in action or who passed away as a result of injuries experienced while on active duty) become homeowners. No down payment is required for a VA loan, although to qualify, you’ll not only have to meet certain veteran status requirements, but you’ll also have to have a minimum credit score of 620. However, it’s worth noting that some lenders have minimum credit score requirements for VA loans that are as low as 580.
USDA Loan Credit Score Requirements
USDA loans were established by the U.S Department of Agriculture as a way to promote homeownership in the more rural and suburban areas of the country. Besides the fact that the property has to be located in an eligible area (as defined by the USDA), borrowers must have a minimum credit score of 640.
Conventional Loan Credit Score Requirements
Conventional loans are loans that are not backed by the federal government. Because they aren’t insured, lenders take on a greater risk when approving conventional loans. Although the minimum credit score is usually around 620, it’s worth noting that low credit scores greatly affect the terms of a conventional loan, from the down payment required to the amount of interest you’ll have to pay. For example, if you have a 620 credit score, you’ll pay higher interest than if you had a 700 credit score. The less favorable rates help offset the risk of lower credit scores.
Check Your Credit Score Online
Before you apply for a mortgage, you’ll want to know what your credit score is so that you can determine whether or not you’ll be eligible. You can easily check your credit score online. Many banks and credit card issuers can provide you with your credit score. You can also request a credit report, which contains your credit score, from one of the three credit bureaus (Equifax, TransUnion, and Experian).
The majority of lenders use FICO (Fair Isaac Corporation) scores, which range from 300 to 850. You’re entitled to one free credit report a year. When looking at credit reports from all three credit bureaus, you may find that they vary slightly; however, they should be pretty close to the same number. Your FICO credit score is based on a variety of factors, including the following:
Your payment history – Your payment history accounts for 35 percent of your score. It takes into account your history of paying bills, such as how often you’re late and whether there are any blemishes related to non-payments on your credit report, such as bankruptcies, debts sent to collections, or foreclosures.
Your debt – The amount you owe accounts for 30 percent of your score. This includes the balances on your credit cards and any installment loans you have.
Your credit history – This refers to how old your accounts are. The average age of your accounts is worth roughly 15 percent of your score.
Your credit mix – The more balanced your credit is, the better. For example, if you only have credit card accounts, then it’s not a very balanced mix. Your credit mix accounts for 10 percent of your score.
New credit – Recently opened accounts and new credit inquiries can hurt your score a bit. New credit accounts for 10 percent of your score.
Beyond The Credit Score
While your credit score certainly provides lenders with a decent idea of your financial responsibility and capabilities, it’s not the end-all-be-all of your ability to qualify. Lenders take into account other factors as well. For example, if you have a lower credit score, they may still approve your application if you have a lower LTV ratio (meaning you put down a larger down payment), have a low debt-to-income ratio, and have significant income. In many cases, these things can help offset the risk of a low credit score.
Compensating Factors For Bad Credit
The following is a more detailed look into some of the other factors lenders will look at if you have bad credit:
Low Loan-to-value Ratio
The loan-to-value ratio of a mortgage is the ratio between the value of the home loan and the actual value of the home. You can lower the loan-to-value ratio by making a larger down payment. Lenders view borrowers with a lower loan-to-value ratio as less of a risk because they will have more equity in their home off the bat. This means that if the borrower does default, the lender will have a better chance of recovering the balance of the loan owed during the foreclosure process.
If you have a significant amount of money in savings, it shows lenders that you can not only make a large down payment but that you’ll be able to cover your mortgage payments for an extended period of time even if you were to become unemployed for a period. Lenders assume that the more money you have in savings, the less likely you will be to default on your loan.
A high income shows that you have the means to pay for your mortgage on a monthly basis. The more you make, the less likely it is that you’ll be unable to make your mortgage payments.
Low Debt-to-income Ratio
The less debt you have, the better. It means that your mortgage will be your number one priority and that your ability to pay it won’t be hindered by other debts. It’s one of the reasons why lenders typically value a lower debt-to-income ratio over a high overall income (you can have a high income and be absolutely saddled with debt, after all).
Long Employment History (With Current Employer)
Most lenders want to see a long employment history (at least two years with the same employer) as this indicates you have a stable income. The longer your employment history is, the more stable your job will be perceived as. In the eyes of the lender, this means that you’re less likely to lose your job, thereby making it difficult to make your monthly payments.
Qualifying Credit Score Ranges
While knowing what the minimum credit scores are for each type of loan is helpful, knowing what the different credit score ranges are will give you an idea of whether you can qualify for more favorable terms as well. The following are the specific credit score ranges that you should be familiar with:
Very Good: 740-799
Very Poor: 300-579
Credit Score Vs. Interest Rate
Your credit score won’t have much of an impact on interest rates when it comes to certain types of loans, such as FHA loans. However, they will impact your interest on a conventional loan. There’s no set interest rate based on credit score ranges due to the fact that interest rates vary based on the market and because lenders take into account other factors besides your credit score when determining your interest rate as well. However, if you have fair credit, you can expect to pay as much as 1 to 2 percent more on your interest rate than if you have exceptional credit. This could end up costing you tens of thousands of dollars in interest by the time that you’ve paid off your mortgage.
Mortgage Denial Rates
Credit Sesame conducted a survey between 2016 and 2017 in which they questioned 600 Americans about their credit scores and their mortgage application experiences. It was found that the higher a person’s credit score was, the more likely it was that they would be approved. The study looked at two types of mortgages — $70,000 mortgages and $150,000 mortgages. While rejection rates were higher for $150,000 mortgages, just like with the $70,000 mortgages, the higher the credit scores were, the less likely borrowers were to be denied.
How To Improve Your Credit Score
As you can see, the better your credit score is, the more likely that your mortgage application will be approved–not to mention that higher credit scores can result in more favorable interest rates if you’re planning on applying for a conventional loan. Because of this, it’s worth taking the time to improve your credit score, especially if it’s not in the best shape. The following are a few tips for improving your credit score:
Pay Credit Card Balances
A high credit utilization ratio will hurt your credit score. The balance on your credit cards should be no more than 30 percent of the credit available. Work towards paying down your credit card balances and you should help to improve your score.
Pay For Delete
If a debt remains unpaid for too long, it will likely be sent to a collection agency. Any debts that have been sent to collections will show up on your credit report and can ding your credit score by upwards of 100 points. If you have any collections on your account, it’s worth contacting the collection agency to ask if you can pay to have it removed from your credit report. Many creditors are willing to remove the account from your report if you can pay for the amount owed in full.
Become An Authorized User
If you have any friends or family members who trust you and are willing to help out, ask them if they will put you on their credit card as an authorized user. If they have good credit, then doing this can help improve your credit by as much as 30 points. Of course, if they have bad credit, then this won’t help you at all.
Review Your Credit Report
Request a copy of your credit report and look over it carefully. Credit reports can have mistakes on them. Look for any mistakes, such as debts that shouldn’t be on there. You can report these errors and request that they be taken off. The removal of such mistakes can help bump up your credit score.
What’s Inside Your Credit Report?
Your credit report includes all of your accounts, such as credit cards and loans, on which you owe money. It also includes inquiry information (every instance in which someone pulled a copy of your credit report) as well as bankruptcy and collection information. It’s not uncommon for errors to show up on your report. For example, you may have come to an agreement with a creditor to have an account in collections removed after paying it in full. If it’s still on there and it shouldn’t be, you can report it.
Your credit score has a big impact on your ability to qualify for a home loan; however, it’s not the only factor that a lender will look at. Either way, it’s worth improving your credit score if possible in order to not only improve your chances of qualifying but to improve the terms of your loan (if you’re applying for a conventional loan).
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