At a Glance
Buying your first home is an incredibly exciting milestone, but it can also be a daunting one. With so many factors to consider, like location, price range, and mortgage options, it’s understandable if you’re overwhelmed. One of the most important things to remember is your credit score. Your credit score will play a significant role in determining whether you’re approved for a mortgage and the interest rate you’ll be offered. Even if your credit score isn’t currently where you want it to be, there are steps you can take to improve it and increase your chances of securing your dream home.
In this article, you’ll learn:
Points Is the highest amount your credit score can drop when you take out a mortgage. However, this typically corrects after about five or six months, assuming you keep practicing healthy financial habits.
Credit score needed to buy a house by mortgage types
1. Conventional loan
A conventional loan is a type of mortgage loan not insured or guaranteed by the government, like the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA). Instead, conventional loans are backed by private lenders, like banks or mortgage companies.
To qualify for a conventional loan, you typically need a credit score of at least 620. Remember that the minimum credit score required can vary by lender, and some lenders may require a higher score, like 680 or higher.
2. FHA loan
An FHA loan is a mortgage insured by the Federal Housing Administration (FHA). FHA loans are designed to make homeownership more accessible to borrowers who may not qualify for conventional loans due to lower credit scores, smaller down payments, or other factors.
One of the benefits of an FHA loan is that it typically has more lenient credit score requirements than conventional loans. While the specific credit score requirements can vary depending on the lender and other factors, the FHA typically requires a minimum credit score of 580 to qualify for an FHA loan with a 3.5% down payment. However, some lenders may require a higher credit score, and borrowers with credit scores between 500 and 579 may still qualify for an FHA loan with a 10% down payment.
In addition to credit score requirements, FHA loans have other conditions, like limits on the amount you can borrow and restrictions on the types of properties you can purchase. Working with a lender experienced in FHA loans is important, as they can guide you through the application process.
3. VA loan
A VA loan is a type of mortgage loan backed by the U.S. Department of Veterans Affairs and is available to eligible veterans, active-duty service members, and certain surviving spouses. VA loans typically offer more favorable terms than conventional loans, including lower interest rates, no down payment requirement, and no private mortgage insurance (PMI) requirement.
The VA does not have a minimum credit score requirement, but most lenders that offer VA loans typically require a credit score of at least 620. However, some lenders may require a higher score, depending on the borrower’s specific financial situation and credit history.
4. USDA loan
A USDA loan is a mortgage loan program offered by the United States Department of Agriculture (USDA) to help people purchase homes in rural and suburban areas. USDA loans are designed to encourage homeownership in areas that are not densely populated and to support the growth of rural communities.
To qualify for a USDA loan, you must meet certain eligibility criteria, like:
- The property you’re purchasing must be located in an eligible rural or suburban area as defined by the USDA.
- You must have a steady income and be able to afford the mortgage payments.
- Your debt-to-income ratio should be no higher than 41%.
- You must be a U.S. citizen, permanent resident, or have a valid non-citizen status.
- You must have a minimum credit score of 640 or higher. However, some lenders may have different credit score requirements, so it’s a good idea to check with multiple lenders to see their specific requirements.
5. Jumbo loan
A jumbo loan is a type of mortgage that exceeds the conforming loan limits set by the Federal Housing Finance Agency (FHFA). These limits vary by geographic area, but the conforming loan limit for most of the United States was $548,250 in 2021. Jumbo loans are typically used to finance more expensive properties, like luxury homes or homes in high-cost areas.
The credit score required to qualify for a jumbo loan can vary depending on the lender’s specific requirements and other factors. However, generally, borrowers will need a credit score of at least 700 to qualify for a jumbo loan. Some lenders may require even higher credit scores, up to 720 or more.
What is a good credit score to buy a house?
The credit score needed to buy a house varies depending on the type of loan and the lender’s requirements. Generally, a good credit score for buying a home is typically 680 or higher. However, to qualify for the best interest rates and terms on a mortgage, a credit score of 740 or higher is generally preferred.
How does your credit score affect mortgage rates?
Your credit score can have a significant impact on the mortgage rates that lenders offer you. The higher your credit score, the lower the interest rate you may be offered on a mortgage. This is because a higher credit score indicates to lenders that you are a lower-risk borrower and more likely to make timely payments.
For example, a borrower with a credit score of 760 or higher may be offered a mortgage rate of 3.5%, while a borrower with a credit score of 620 may be offered a rate of 5.5% or higher. Over the life of a mortgage, even a slight difference in interest rates can result in significant savings or costs.
In addition to affecting the interest rate, your credit score can also affect the terms of your mortgage, like the size of your down payment or the type of loan you qualify for. To get the best mortgage rates and terms possible, it’s important to maintain a good credit score by paying bills on time, keeping credit utilization low, and monitoring your credit report regularly for errors or fraudulent activity.
Why does your credit score matter to lenders?
Your credit score matters to lenders because it indicates your creditworthiness, which is the likelihood that you will repay your debts on time. When you apply for a loan or credit, lenders want to know how risky it is to lend you money. Your credit score is one of the most important factors lenders consider when evaluating your creditworthiness.
A high credit score indicates to lenders that you are a lower-risk borrower and more likely to make payments on time, while a low credit score suggests that you are a higher-risk borrower and may be more likely to miss payments or default on the loan. Therefore, a higher credit score may make it easier for you to obtain credit at favorable terms, like lower interest rates and fees, while a lower credit score may result in higher interest rates and fees or even a denial of credit.
How to improve your credit score before buying a house?
Improving your credit score before buying a house can help you get better mortgage rates and save you money over the life of the loan. Here are some steps you can take to improve your credit score:
- Check your credit report: Review your credit report from each of the three major credit bureaus to ensure that all information is accurate and up-to-date. If you find errors, dispute them with the credit bureau.
- Pay bills on time: Late payments can have a significant impact on your credit score. Pay all bills on time, including credit cards, loans, and utilities.
- Reduce credit utilization: Keep your credit utilization ratio (the amount of credit you use compared to your credit limit) below 30%. High credit utilization can indicate to lenders that you are overextended and may be a higher-risk borrower.
- Pay down debt: Pay down credit card balances and other obligations to reduce your overall debt-to-income ratio, which is the amount of debt you have compared to your income.
- Avoid opening new credit accounts: Opening new ones can temporarily lower your credit score, so it’s best to avoid doing so before applying for a mortgage.
- Maintain good credit habits: Continue to use credit responsibly by paying bills on time, keeping credit utilization low, and avoiding missed payments and defaults.
Related: How to Improve Your Credit Score?
Other considerations when buying a house
1. Debt-to-income ratio
The ideal debt-to-income (DTI) ratio for buying a home can vary depending on the lender’s specific requirements and other factors. Generally, lenders prefer a DTI ratio of 43% or lower, although some may allow a higher DTI ratio in certain circumstances.
To calculate your DTI ratio, add up all of your monthly debt payments (like credit card payments, car loans, student loans, and other debts) and divide them by your gross monthly income (your income before taxes and other deductions are taken out). This will give you a percentage that represents your DTI ratio.
For example, if you have $2,000 in monthly debt payments and $6,000 in gross monthly income, your DTI ratio would be 33% ($2,000 divided by $6,000).
Related: How Much Debt Is Too Much Debt?
2. Loan-to-value ratio
The ideal loan-to-value (LTV) ratio for buying a home can vary depending on the type of loan and the lender’s specific requirements. Generally, an LTV ratio of 80% or less is considered ideal for conventional loans, meaning you would be borrowing no more than 80% of the home’s appraised value.
This is because a lower LTV ratio means you will have more equity in the home, which can help protect you from potential losses if property values decline. A lower LTV ratio can help you qualify for a better interest rate and avoid the need for private mortgage insurance (PMI).
However, some loan programs, like FHA loans, allow for higher LTV ratios. FHA loans may allow for an LTV ratio of up to 96.5%, meaning you would be borrowing up to 96.5% of the home’s appraised value. However, this typically requires you to pay mortgage insurance premiums (MIP).
3. Income and assets
Considering your income and assets when buying a house is important because they can impact your ability to qualify for a mortgage and determine how much home you can afford. It will also determine how much you can set aside for a down payment and a monthly payment. Working with a financial advisor or mortgage professional can help determine the best course of action based on your unique financial situation.
Buying a house with bad credit is possible, but it can be more difficult and may result in higher interest rates and fees. Lenders use credit scores to evaluate the risk of lending money to borrowers. A low credit score indicates the borrower is at a higher risk and may be more likely to miss payments or default on the loan.
If you have bad credit, there are a few options to consider:
- Improve your credit score: Before applying for a mortgage, work on improving your credit score by paying bills on time, reducing credit card balances, and disputing errors on your credit report.
- Save for a larger down payment: A larger down payment can help offset the risk of a low credit score and may make you a more attractive borrower to lenders.
- Consider alternative lenders: Some alternative lenders, like online lenders and peer-to-peer lending platforms, may be more willing to work with borrowers with bad credit.
- Get a co-signer: A co-signer with good credit may help you qualify for a mortgage and get better terms.
- Consider a government-backed loan: Some government-backed loans, like FHA loans, may be more accessible to borrowers with bad credit.
Mortgage lenders typically use a variety of credit scores when evaluating a borrower’s creditworthiness. However, the most commonly used credit score is the FICO score, which was developed by the Fair Isaac Corporation.
FICO scores range from 300 to 850 and are calculated based on information from credit reports from the three major credit bureaus. FICO scores consider factors like payment history, credit utilization, length of credit history, types of credit used, and recent credit inquiries.
Mortgage lenders may use different versions of the FICO score, like FICO Score 8 or 9, or they may use a different credit scoring model altogether. Additionally, lenders may use custom scoring models that are tailored specifically to their business needs.
There is no specific “minimum” credit score required to buy a house, as credit score requirements can vary depending on the type of loan, the lender’s specific requirements, and other factors. A credit score of 620 or higher is often considered the minimum score needed to qualify for most conventional loans.
Keep in mind that even if you have a credit score of 620 or higher, you may still face challenges in getting approved for a mortgage if you have a high debt-to-income ratio, a history of missed payments, or other financial issues.
If you have a credit score below 620, qualifying for a conventional mortgage may be more difficult. However, other options exist, like FHA loans, which are designed for borrowers with lower credit scores and smaller down payments. Some lenders may offer alternative loan programs for borrowers with low credit scores, although these may come with higher interest rates and fees.
The time it takes to build credit before buying a house can vary depending on your starting credit score and how much you need to improve it. Generally, it’s a good idea to start working on building your credit as soon as possible, as this can help you qualify for better mortgage rates and terms.