How Your Credit Score Affects How Much House You Can Afford
There are a lot of factors to consider when buying a home. Things like square footage, school districts, distance to the nearest grocery store and more. One thing you probably don’t want to think about? How your credit score affects your ability to buy your dream home. That’s why we thought about it for you. We want to outline how your credit score affects your eligibility for a mortgage — and why — so you can go back to picking out the perfect backsplash for your new kitchen.
How your credit score affects your mortgage
Your credit score and credit report are both used to determine if you qualify for a mortgage and the interest rate you’ll receive.
We all have multiple credit scores, but mortgage lenders are most likely to use your FICO Score when considering you as a lender. (See below for a fuller discussion of FICO Scores and the credit reporting agencies.) But when shopping for a mortgage, the rule of thumb is that a higher credit score will generally get you a lower interest rate.
You may also be able to get a lower interest rate by putting down a larger down payment. A large down payment may help those with lower credit scores keep their mortgage loan interest rate down, too.
Check out the Consumer Financial Protection Bureau’s interest rate tool to play around with the rate and mortgage term (length of your loan) to see what your interest costs may be. The shorter the mortgage term, the higher your monthly payments are, but the less you’ll pay in interest.
Why lenders care so much about your credit score
When a lender offers you money for a mortgage or other loan, they are putting faith in you that you will pay their money back. If a lender sees that you have a poor credit score and an unreliable credit history, it’s understandable that they may not want to take a chance on you.
If you have an unfavorable score or credit history that you think can be explained, the Federal Trade Commission recommended explaining your situation to lenders. You may want to discuss minor credit problems caused by illness or an unexpected loss of income and assure the lender that you’ll make your payments reliably.
A specific credit score is not required for you to receive a mortgage loan. USA.gov recommended doing your homework on your loan options. Evaluating different lenders will help you find the right interest rate, length, monthly payment and other factors for your budget and lifestyle.
If you have a low credit score, you may want to consider a Federal Housing Administration (FHA) loan, which allows for a down payment as low as 3.5%. FHA loans are designed for borrowers with low credit scores and can be the least expensive option for those borrowers. However, according to the Consumer Financial Protection Bureau, for borrowers with good credit and a higher down payment (10% to 15%), an FHA loan may prove to be more expensive than a conventional loan.
Knowing your credit score may not be enough
You may hear the term FICO Score thrown around a lot while shopping for a mortgage loan. A FICO Score is just one particular brand of a credit score. It can be used to predict how reliable you are when it comes to paying back a loan on time. That’s why the higher your score, the more likely you are to receive favorable loan terms.
A FICO Score is determined by the content of your credit report. The three major credit bureaus are Experian, Equifax and TransUnion. The bureaus may report your data differently based on the sources they collect information from, meaning your FICO Score can vary based on which bureau’s data is used to calculate it. FICO also has industry-specific scoring models designed for credit card issuers and auto lenders.
Base FICO Scores
A variety of factors determine your credit score, including:
- The number and type of accounts you have (credit cards, auto loans, mortgages, etc.)
- Whether you pay your bills on time
- How much of your available credit you are currently using
- Whether you have any collection actions against you
- The amount of your outstanding debt
- The age of your accounts
Your score is based on information collected from creditors and other sources, such as:
- Credit card issuers
- Auto finance companies
- Public records (bankruptcies)
Other factors mortgage lenders consider
Along with your credit score, a lender may also consider certain requirements relating to income level and your ability to repay your loan on time. Other considerations may include:
- Home location
- Home price and loan amount
- Down payment
- Loan term
- Interest rate type
- Loan type
Finding your home
Even if you don’t have the highest credit score, there are ways to make yourself more attractive to mortgage lenders. It’s never a good idea to overextend yourself, but a less-than-perfect credit score doesn’t have to keep you from snagging your dream home.