What Credit Score Do You Need to Buy a House?
Credit scores are one of the principal factors lenders consider when you’re applying for a mortgage. But it can be disconcerting to learn that your homeownership future partially hinges on this hard-to-understand number.
What’s good enough? What doesn’t cut it? And how hard-and-fast are these credit requirements, anyway?
This article should give you a better sense of the role your credit score plays.
What credit score do you need for various types of mortgages?
One thing is crystal-clear: There are many different types of mortgages to choose from. Here are the minimum credit score requirements for the major programs:
|What Credit Score Do You Need to Buy a House?|
|Mortgage Type||Minimum Credit Score|
|VA||No minimum (whole loan profile reviewed)|
You’ll want to see where your credit score stands now, and monitor where it goes as you work to improve it.
Do lenders abide by minimum score requirements?
To understand how firm credit score requirements are, it helps to take a step back and first talk a bit about how the mortgage industry operates.
Here’s a critical piece of information: Most mortgage lenders aren’t interested in keeping your loan. They’re far more likely to sell it to another entity, whether that be a bank like Wells Fargo or the government-sponsored enterprises Fannie Mae and Freddie Mac. In this way, lenders actually view your mortgage as a product.
The entities to which your lender sells mortgages each have their own acceptance standards, including minimum credit requirements. They don’t want bad mortgages — remember all that happened with the housing mess of 2008?
That’s where minimum score requirements for conventional loans come into play. A lender could accept a credit score below 620 for a conventional mortgage, but Fannie Mae wouldn’t buy that loan, and the lender might be stuck with it unless it can find another buyer.
Can lenders require scores higher than the minimum?
Short answer: Yes.
Because mortgage lenders often view your mortgage as a product, each individual lender might have different (and stricter) requirements for getting a mortgage. These are known as lender overlays: extra requirements an individual lender might inject into the process, above the minimums for a particular type of mortgage.
“If a bank continuously writes bad loans and sells them to an investor, then you might not want to buy loans from that bank anymore,” says Joe Burm, a credit counselor with the nonprofit credit counseling agency GreenPath Financial Wellness. “So they might want to be a little more protective in making sure that they’re not writing bad loans.” Basically, stricter lending requirements are a way for mortgage lenders to guarantee a better product for the people buying the loans.
Additionally, lenders are subject to much more scrutiny and regulation in the aftermath of the 2008 financial crisis. According to Burm, a lender may set stricter mortgage requirements to avoid getting embroiled in any regulatory trouble.
How your credit score can affect your home loan
Your credit score affects more than just loan approval. It also affects terms.
Your credit score could likely dictate your mortgage interest rate, for one thing, says the Consumer Financial Protection Bureau. Generally, the lower your credit score, the higher the interest rate, because lenders view borrowers with a low credit score as higher-risk — that is, they’re seen as more likely to miss loan payments or even slide into default. So such customers may be charged a higher rate to compensate for that perceived greater risk.
Similarly, you might need a bigger down payment if you have a lower credit score. For example, you may be able to get an FHA loan with a down payment of just 3.5 percent if your credit score is 580 or above. But say your score lands somewhere between 500 and 579. You may, in fact, still be able to get an FHA loan (if you can find a lender that’ll approve you), but you may need at least 10 percent for a down payment.
Finally, your credit score can determine how much home you can get. Because you’ll need a bigger down payment with a low credit score, you might need to focus on a cheaper home.
Good news: Your credit score is not the only factor when it comes to buying a house
Although everyone places a lot of emphasis on the almighty credit score, it’s only one piece of the puzzle as lenders consider you for a mortgage approval.
Indeed, loan-to-value ratio is another important puzzle piece. That’s a ratio of the size of the loan to the value of the home. If you’re putting up a large down payment, the loan-to-value ratio will be smaller. It’s less risky that you’ll default on a loan if you’ve basically already paid a large chunk of it off, so lenders may be more willing to approve you for a mortgage if you’re coming to the table with a bigger chunk of cash to put down.
Your debt-to-income ratio measures what percentage of your gross income (earnings before taxes) goes toward debt payments each month. The more obligations you have elsewhere, the greater the chances that you’ll default on a mortgage, which is why lenders may be more likely to approve you for a loan if you have a small debt-to-income ratio. In fact, many lenders won’t approve you for a loan at all if your debt-to-income ratio exceeds 43 percent.
Lenders will also look at how much money you have on hand in easily accessible accounts, like savings or checking accounts, as opposed to cash tied up in retirement accounts or trust funds. The amount of liquid assets you need to have on hand depends on how large a mortgage you seek and what type you apply for, among other things.
Your current income and employment history are also very important to lenders. They want to know you have steady employment and the monthly cash flow necessary to make your mortgage payments. This can be hard if you’re a self-employed business owner or a freelancer, because you’ll generally need to show at least two years’ worth of tax returns to prove your income.
Of course, you can also boost your chances of approval by bolstering other mortgage-approval criteria: saving up a large down payment, paying down your debt, improving your credit score.
Getting your credit score where it needs to be
It is possible to improve your credit score with hard work and time. Plus, the things you do to increase your score will improve your overall financial profile and make it all the more likely you’ll be approved for a mortgage with the best terms possible.
To understand how to improve your credit score, it’s important to understand what goes into that calculation. There are many types of credit scoring models, but the most common one used by lenders is your FICO score. Here’s how it breaks down:
- Payment history: 35 percent of your score
- Amounts owed: 30 percent
- Length of credit history: 15 percent
- Credit mix: 10 percent
- New credit: 10 percent
It’s clear from these percentages that the biggest factor in your credit score is whether you make payments on time. Setting up your bills on autopay will be the single easiest way to accomplish this. If you’re not comfortable with automatic payments, put reminders on your calendar or somewhere else where you’ll be certain to see them.
The amount of debt you owe is the second-biggest factor in determining your credit score. If you owe any debt, it can be quite beneficial to take care of it as fast as possible, or at least get your debt down to a reasonable level. Not only will you save on interest payments, your credit score will improve, your debt-to-income ratio will drop and, ideally, you may be eligible for better interest rates on your mortgage. Focusing on high-interest-rate debt (like credit card debt) first is a very efficient way to pay off your debt.
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 there’s an annual fee involved and you’re not using it. Similarly, avoid opening any new credit cards or loans if possible — they’ll decrease the average length of your credit history, and could ding your score.
Credit mix 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. Sure, opening a new type of credit can boost your score. But it’s generally not advised to do this just to do so because the increase will be minimal (your mix is only 10 percent of your score, after all), and it doesn’t make sense to take on debt you don’t need.
Besides, your credit score will be dinged a few points from opening a new line of credit. It’s better to play it safe and open up only those lines you absolutely need. For more on how to better understand your credit score, check out this guide from our subsidiary MagnifyMoney.
Shop for lenders
No matter your credit score, it can pay off big time to consider multiple mortgage lenders when buying a home.
For example, let’s say you want to take out a $250,000 mortgage and have two loan offers — one at 4 percent and the other at 3.5 percent. Over the course of a 30-year mortgage, you’ll pay $25,532 more in interest with the 4 percent variant. Just a few percentage points can count for a lot of cash.
Make sure to shop around for rates with local mortgage lenders, banks and credit unions. You can start by comparing multiple lenders in one place here on LendingTree.