What Credit Score Do You Need to Buy a House?
One of the first things you’ll need to know if you’re starting to shop for a house is your credit score. Your credit score will determine how high or low your interest rate is, how much of a down payment you need to give and even how much a house you can buy. Plus, it’s a vital part of getting preapproved for a mortgage.
Many loan programs require at least a 620 credit score if you want to make the lowest down payment possible. Others may give you flexibility for a lower credit score, or may not require a score at all and look at other factors to determine your creditworthiness — the chart below shows provides a quick look at the standard minimum mortgage program credit scores.
|What Credit Score Do You Need to Buy a House?|
|Mortgage Type||Minimum Credit Score|
|VA||No minimum (whole loan profile reviewed)|
There are several tactics you can use before, during and after your home search to improve your scores. You should also take care to avoid several actions that can cause a sudden drop in your score before you buy a house. This article will go into detail on both sides, as well as what scores you’ll need to buy a home.
We will cover:
- What is a credit score?
- How your credit score is calculated
- What is the minimum credit score you need to buy a home?
- What credit score do you need to get the best rate?
- What credit score do you need if your debt-to-income ratio is high?
- How your credit score can affect private mortgage insurance costs
- Strategies for improving your credit score
- What if I don’t have a credit score?
What is a credit score?
Every account you open, payment you make and loan you apply for contributes to the three-digit number known as your credit score. They typically range from 300-850 and give lenders an indicator of how likely you are to pay your bills on time.
Most people become acquainted with the concept of credit scores when they apply for their first credit card or car loan. They become even more important when you go to buy a house. To a mortgage underwriter, how you’ve paid other debt is a good indicator of how well you’ll handle the much bigger commitment of a 30-year mortgage loan.
Mortgage lenders take credit scoring very seriously — so seriously that they ask for a second, and a third opinion by drawing information from three different credit bureaus — Equifax, TransUnion and Experian. This is to ensure that one bureau doesn’t miss something that could result in them making a loan that defaults, or that they don’t penalize you for something that is reported in error on your report.
How your credit score is calculated
There are many types of credit scoring models, but the most common one used by lenders is called a FICO score.
In this model, making payments on time has the most impact on your scores. Setting up your bills on autopay is an easy to way to accomplish this. If you’re not comfortable with automatic payments, set aside a specific time every couple of week to pay all of your bills, or better yet, budget so that you can pay them all at the beginning of the month.
The amount of debt you owe, compared to the total you could charge has the second-biggest impact impact on your credit score. This is called your “credit utilization ratio.” The closer your credit cards are to being maxed out, the lower your credit score will be. If you owe any debt, pay it off as quickly as possible possible or at least keep the balances as low as you can.
Your length of credit history is averaged across all of your credit accounts. The older your accounts, the more they’ll help you, so avoid closing old credit cards unless you have to pay an annual fee. Similarly, avoid opening more than a few new credit cards or loans in a short time period — they’ll decrease the average length of your credit history, and could ding your score.
The fourth factor is referred to as credit mix and simply refers to the different types of credit you have: revolving and installment. Credit cards are a form of revolving credit, and installment loans include things like student, auto and personal loans. The more different types of credit you’ve used, the higher your score will generally be. Credit mix only represents a small part of your score, so it’s really not worth opening several new different types of credit to try to boost this portion of your score.
The final factor is called the new credit portion of your score has to do with applying for new lines of credit, which may drop your score a few points. One common mortgage shopping myth is that your scores will drop if you have too many companies running your credit at once.
The truth is there is very little, if any, effect if you apply in a 30-day period, since the mortgage credit scoring system recognizes multiple inquiries from mortgage companies as only one.
- Payment history: 35%
- Amounts owed: 30%
- Length of credit history: 15%
- Credit mix: 10%
- New credit: 10%
What is the minimum credit score you need to buy a home?
Your credit score is important to determining whether you can qualify for a home, but the minimum you need varies drastically depending on the type of loan you are applying for. You might be surprised to learn that if you don’t have a credit score, you can still get a mortgage.
We’ll start by discussing the minimum scores you’ll need to qualify for a mortgage based on the different types of loan programs that exist.
If you have a low credit score, you’ll have the easiest time getting qualified for an FHA loan. The Federal Housing Administration provides insurance to the companies that make the loans, and the program allows for scores as low as 580 with a down payment minimum of 3.5%. With a 10% down payment, you could even get financing with a score as low as 500.
This program refers to loans that can be purchased by Fannie Mae and Freddie Mac, government-sponsored enterprises that buy loans made under certain guidelines. The minimum credit score to qualify is 620, and there are programs available with down payments as low as 3%.
If you are currently serving in the military or are a veteran, you may be eligible for the VA loan guarantee. This allows eligible service members to purchase a home with 0% down payment financing. Although the VA lending guidelines do not indicate a minimum score, most lenders offering VA loans will require at least a 620 score.
Lower credit scores can be accepted under special circumstances. VA underwriting takes a broader look at borrowers’ credit profiles, especially since credit issues may been the result of a sudden call to active duty, or recovery from a service-related injury or disability.
The U.S. Department of Agriculture provides mortgages to low- to moderate-income families to buy houses in designated rural areas of the country through the USDA loan program. The credit score minimum is 640, although lower scores may be approved on a case-by-case basis.
What credit score do you need to get the best rate?
While you’ll qualify for a mortgage with the minimum credit score, you’ll face consequences of a lower score in the form of a higher interest rate and mortgage payment.
This is due to something called loan level price adjustments. The mortgage industry uses pre-set markups that increase interest rates the lower your scores are.
For example, if you are putting down 3% and have a 740 credit score, the markup on your interest rate is 0.75% of the loan amount. If you have a 620 score, the mark up to the cost of the rate is 3.75% of the loan amount. These get baked into the interest rate you pay, which translates to a higher monthly payment.
Let’s look at how would translate to cost on a $200,000 loan. For the 740 credit score, the effective cost of the FICO credit score pricing adjustment is 0.75%, or $1,500.
For a 620 score, the cost of the price adjustment is 3.75%, or $7,500. The lenders can’t deliver these loan to agencies like Fannie Mae or Freddie Mac unless they collect these pricing adjustments, so rather than charge you the actual dollar amount, they just increase the interest rate.
What credit score do you need to make the lowest down payment?
In some cases, a lower credit score may require you to make a bigger down payment.
To get an FHA loan, the minimum score for you to make a minimum down payment is 580. If your score drops even one point less to 579, your minimum down payment requirement goes from 3.5% to 10%.
Some conventional lenders may also have different requirements for different credit scores. Some may require a higher down payment if your score is below 660 or 640, even though the program guidelines indicate the minimum is 620 for a 3% down payment program through Fannie Mae and Freddie Mac.
What credit score do you need if your debt-to-income ratio is high?
Behind credit scores, the second-most important factor affecting your mortgage loan approval will be how much debt you have compared to your pre-tax income. This is known as your debt-to-income ratio, or DTI. A higher DTI and a low credit score may create approval problems.
Federal regulators prefer a DTI for a loan lower than 43%. This benchmark is used in the qualified mortgage rules implemented after the housing crisis. However, exceptions are possible, but those exceptions usually depend on how good your credit scores are.
How your credit score can affect private mortgage insurance costs
If you are making less than a 20% down payment, you will be required to pay private mortgage insurance (PMI) on a conventional loan. The insurance protects lenders in the event that you fail to make payments. Although it does add an extra monthly component to your payment, mortgage insurance also allows many people who aren’t able to save up tens of thousands of dollars an opportunity to purchase a home.
The lower your credit scores, the more you will pay for PMI. This is an important consideration when you are getting approved for financing, because a conventional mortgage could quickly become unaffordable if you combine the interest rate and mortgage insurance markups. If your credit score is below 680, you may look into an FHA loan.
Strategies for improving your credit score
If your scores aren’t where you want them to be, following the steps below will improve your scores — saving you money when it comes time to get preapproved for a mortgage.
- Don’t stop using credit: This may seem like strange advice, but your credit score is driven by how you use credit, so if you completely stop using any credit, your score can actually drop.
- Don’t close out accounts: You want to show that you can manage multiple accounts, even if you don’t use some of them very often. Lenders also review your “depth” of credit, an indicator of how many different accounts you can manage at a time and having several open accounts will help show this.
- Don’t apply for a lot of new credit at once: The credit reporting system doesn’t have any way to differentiate whether you ended up opening up new credit as a result of the inquiries on your report. This could drop your score.
- Keep credit card balances low: Keeping your balances at 30% or less of your limit will keep your scores on the higher side. That means you shouldn’t charge more than $300 for every $1,000 of credit you have access to.
- Pay bills on time: This is the most important factor in your credit scores. The more recent the late pay, the lower your scores will be, so you may want to consider waiting awhile to apply for a mortgage if you’ve had some recent missed payments on any credit accounts.
Rapid rescore can be a quick fix
In the normal credit scoring process, it takes 30 to 60 days for changes such as lower credit card balances or new accounts opened to reflect in your credit scores. If you currently have a credit score that’s just slightly lower than what you need, lenders may offer you the option of something called a “rapid rescore,” which can reduce the timeline for reflecting changes in your credit profile down to three to five days.
This allows your credit profile to accurately reflect your situation and give you the best score possible. There is a cost for this process, and it is usually paid by the lender or bank you are doing business with.
However, this can also work against you. If you decide to charge up any balances while you are waiting for the rescore to come back, your score may not rise as much as estimated, or even worse, could actually drop.
Credit repair is a long-term fix
If you have major issues with your credit, you may want to consider some credit repair options. These often require a longer-term commitment.
Credit repair services
Credit repair services will collect data, review credit reports and work with credit bureaus on your behalf to correct errors. They are knowledgeable about federal laws regarding credit reporting practices and can use this this knowledge to your benefit.
There is usually a cost for these services in the form of a monthly fee, or a fee charged when the services are completed. There is no guarantee that a particular score can be achieved, and your ongoing credit use will affect the results.
Do-it-yourself credit repair
If you are have the time and patience, then DIY credit repair may be worth considering to fix your credit. You start by reviewing your credit report and then follow the dispute process outlined by each credit bureau.
You can use a credit monitoring tool to track your progress as you go along, and even set up pushes so that you are notified anytime there is a change to your score.
What if I don’t have a credit score?
There may be situations where a borrower does not have a credit score but has the income and assets to be able to be approved for a loan. This is common for students who may have recently graduated from college but don’t have much credit history, or someone who recently immigrated to the United States but hasn’t established credit in this country.
To address these cases, lenders have created alternatives to FICO scoring to allow them to get a mortgage with no credit score.
Lenders who offer non-traditional credit options will want to be able to verify a payment history of at least 12 months on both housing-related accounts as well as two or three other monthly bills that you can verify a payment history on. When you are applying for a mortgage, lenders are mostly concerned with how you’ve paid your current housing expense.
You’ll need to provide proof through at least the last year’s worth of rent payments. That can be accomplished by getting 12 months’ worth of canceled checks, or a rental payment history from your property manager or landlord.
They will also want to see that you’ve been able to pay your utilities on time, as evidenced by the most current 12 months of water, electric, cable or other housing related expenses. This shows a lender that you are already used to paying housing-related bills, and will be able to manage a mortgage and the related expenses of homeownership.
The final piece of the non-traditional credit puzzle will usually be two or three other accounts that you pay. Cell phone bills, auto insurance, life insurance or renter’s insurance may all be examples of monthly bills that provide payment history over the last 12 months, and the combination of all of the above can allow a lender to approve you for home loan financing without a credit score.
There are some lenders that will require something called an “Anthem report” if you don’t have traditional credit scores. This is basically a report done by a third-party credit reporting company, that verifies all of the non-traditional credit information above.
You provide the credit reporting company with the contacts, canceled checks or monthly statements, and they produce the Anthem report that the lender uses to approve your loan.
It’s important to remember that your credit score is just one factor lenders use to approve a mortgage loan. They will also look at how stable your employment and income are, how high or low your DTI is and how much savings you will have left after you purchase your home.
If your credit scores are low, you may still get approved for the loan if you have a very low DTI, or have a lot money saved in something like a 401(k) or certificate of deposit. If your new home payment is close to or even lower than what you pay for rent, that may be something that will offset a poor credit score.
Always be prepared to provide a thoughtful explanation for any credit bumps in your road. If you can explain and document why the credit difficulties you had are firmly in the rearview mirror, and show an underwriter how bright your financial future looks ahead, you may be able to overcome initial objections to approving a loan that otherwise might be denied.