Credit Score For A Home Loan: What You Need To Know

If you are thinking of buying a home, check your credit score. Having a high credit score can increase your chances of getting approved for a home loan and can mean a lower interest rate and better terms.

LendingTree talked to experienced loan mortgage experts to find out how your credit score is calculated, what constitutes a good credit score, the minimum scores for certain mortgage types and how to improve your score. Here’s what you need to know when it comes to credit scores and mortgages.

How is your credit score calculated?

First, it’s important to know that there is no one credit score for each person. Consumer credit information is collected by three major credit bureaus — TransUnion, Equifax, and Experian. Data reported to each bureau may differ, which means you could get different credit scores, even when the same scoring model is used to determine the score. On top of that, there are dozens of credit scoring models, and you don’t know which score a lender might use (or which credit report data it’s based on).

Most lenders use FICO scores, but there are actually about 50 FICO scoring models (plus custom scores) out there. The most common credit score scale ranges from 300 to 850. The lower your score, the greater risk you are to a lender. Lenders consider a score of 740 or higher very good — 800 or higher is excellent — and a score above that threshold may help you secure the best terms on a mortgage.

As far as which credit scoring model a lender will use when evaluating your mortgage, it varies, but according to FICO, lenders using Experian data most often use FICO Score 2, those using Equifax data use FICO Score 5, and lenders looking at TransUnion data use FICO Score 4. It’s not crucial to understand the differences in the algorithms used to determine these different scores, but you should know that a high credit score — regardless of scoring model — requires you to make payments on time, keep credit card balances low, and only apply for credit when you need it.

What credit score is needed for a mortgage?

The short answer: You need at least a 500 credit score to get a mortgage. That’s the bare minimum for financing backed by the Federal Housing Administration. But if the lender wants to sell a mortgage to government sponsored entities Fannie Mae or Freddie Mac, the minimum credit score is 620. A conventional loan that does not conform to Fannie and Freddie’s standards (aka a non-conforming loan) doesn’t have set minimums — it’s up to the lender to decide what’s good enough.

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How does your credit score determine the type of loan you can get?

A person’s credit score has a direct effect on what type of loan they will qualify for and how much home they will be able to afford to purchase, said Chad Vincent Hubert, an executive mortgage broker with Novi, Mich.-based Insight Financial Services LLC.

Loan types include FHA loans, guaranteed by the Federal Housing Administration); USDA loans, guaranteed by the U.S. Department of Agriculture; VA loans, guaranteed by the Department of Veterans Affairs and conventional loans, those not backed by government agencies.

FHA loans have the lowest set credit score minimum of the group, and conventional loans have the highest minimum. VA loans do not technically have a credit score requirement, though borrowers should plan to have a fair credit score. However, according to a monthly report from Ellie Mae, the average credit score of a VA loan borrower was 711 in June 2018. Compare that to FHA loans: The FHA lenders handbook lists 500 as the lowest credit score a borrower can have and be eligible for FHA financing.

The lower credit score requirements are part of what has made FHA loans popular. A FICO score of 579 or lower requires a 10 percent down payment, while you can qualify for a loan with as little as a 3.5 percent down payment with a FICO score of 580 or higher. The tradeoff is that you have to pay mortgage insurance premiums, unless you put down at least 20% of the home’s purchase price. The average credit score on an FHA purchase loan was 677, based on Ellie Mae’s June 2018 data.

The minimum credit score for conventional loans is 620, if the lender wants to sell the mortgage to Fannie Mae or Freddie Mac. In June 2018, the average credit score on a conventional purchase loan was 753, according to Ellie Mae.

When it comes to credit scores and interest rates, the higher your credit score, the lower the interest rate you will likely get, Hubert said. However, different lenders offer loans for different credit scores. Hubert’s company, for example, provides conventional loans for borrowers with credit scores as low as 620, USDA loans with scores as low as 580, and FHA and VA loans with scores down to 560. If you have a high credit score, you’ll have more options as a borrower and a stronger negotiating position.

Credit scores tell a lender how likely you are to repay a debt based on your track record of repaying other debts. But your credit score is just one of many factors that a mortgage lender looks at when deciding whether you qualify and at what interest rate, said Roger Ma, a certified financial planner and a licensed real estate agent.

“[O]ther important metrics that lenders also look at are your employment, your income, how long you’ve been at that particular employer and the extent of assets and other debt that you have – your debt-to-income ratio,” Ma said.

Can you get a mortgage with bad credit?

The answer is yes, but it’s much harder and much more expensive. You may be able to overcome bad credit or a really low score if you have a large down payment, can show you have a good track record with your employer or write a letter explaining what caused you to have bad credit and why it won’t happen again.

However, if you don’t qualify right away, Hubert’s advice is to try to increase your credit score by paying down certain debts and avoiding making late payments ever again. It may seem counterintuitive, but opening new credit accounts and making regular payments to those accounts can boost your credit score.

“Occasionally, it may be beneficial for them (borrowers) to open new credit accounts to rebuild their scores and balance out the existing derogatory accounts showing on their credit report,” according to Hubert.

Still, there’s no quick fix to bad credit, so you may have to wait several months or years before these good credit behaviors result in a better credit score — one that may qualify you for a mortgage.

If you have a low credit score, are not a veteran and are not looking to buy in an area eligible for a USDA loan, an FHA loan might be your only option.

Why do lenders look at credit scores in different ways?

Lenders look at credit scores in different ways, often because of their own internal qualification standards. According to Hubert, most of the big banks and direct lenders have overlays — self-created guidelines designed to minimize their risk. As a result, they deny thousands of loans that meet the actual program rules but don’t meet their individual bank guidelines.

In Hubert’s case, all loan applications are run through either desktop underwriter (DU) or loan prospector (LP) software; however, manual underwriting is also an option.

“Even if a borrower does not receive an approve/eligible findings qualification from DU, they still may qualify to have their file manually underwritten,” says Hubert. “This means the underwriter reviews the file to see if it meets all of the requirements to be manually underwritten. This could mean lower debt to income ratio, more reserves in the bank, or a larger down payment. Most brokers do not offer manually underwritten loans. However, we do.”

Hubert works with lenders that offer loans to borrowers with much lower credit scores — from 560 to 619: “We have several vendors that routinely offer closed loans that are in the lower credit score range, and it’s because they don’t have the overlays that the big banks or other direct lenders have.”

How to choose the best lender

If you are in the market for a mortgage, Ma suggested considering not just the interest rate offered but the closing costs, any incentives and the quality of service that the lender offers.

“I would caution people from looking for a lender and comparing just the interest rate. The interest rate is just one component of the whole mortgage package,” Ma said. “While one bank might give you a lower interest rate, it might attach a lot of closing costs.” He also suggested asking about any borrower benefits a lender might offer.

One final factor to consider, according to Ma, is simply the service: “The underwriting process is complex. It can be really confusing. You want a mortgage banker that is going to take the time to educate you, not only about the process but about your various options.”

Before deciding on a lender, compare several mortgage offers to make sure you’re comfortable with your choice. You can fill out an online form with LendingTree to review potential mortgage offers and start your comparison process.

How can you find out your credit score?

You can find out your credit score on LendingTree, but keep in mind it may not be the same score a lender uses.

How can you improve your credit score?

Most lenders use a FICO score, and a few factors go into its calculation. According to FICO, your payment history makes up 35 percent of your score, amounts owed make up 30 percent, the length of your credit history accounts for 15 percent, and your credit mix and new credit account for 10 percent each.

Therefore, paying bills on time is the easiest way to boost your score, followed by paying off existing debt on credit cards (while both installment debts and revolving credit debts are factored into the “amounts owed” category, how much you use of your revolving credit has a greater effect). This can also improve your debt-to-income ratio and may make you eligible for better interest rates on your mortgage.

Old credit card accounts can boost your score, as long as you continue to make on-time payments on them. The length of your credit history is averaged across all of your credit accounts, so don’t close old accounts if you can avoid it. Similarly, don’t open new credit card accounts or loans because that will reduce the average length of your credit history, as well as generate hard inquiries on your credit report, both of which can lower your credit score.