If you’re looking to apply for a loan to buy a home, you’ll need to find out your credit score. Lenders will use your credit score not just to guide their decision on whether to approve your loan or not, but also to set the interest rates and other conditions. Here are the credit scores lenders use for home loans, and how you can achieve your best credit score.
What Type of Credit Score Is Important?
Lenders can request credit reports from each of the three main credit bureaus — Equifax, TransUnion and Experian — but will typically obtain scores from all three. That’s why first-time buyers, in particular, should plan and obtain their 3-Bureau Credit report in advance. There is no fixed requirement for what lenders must do, and individual lenders follow different rules and guidelines. If each score from the three bureaus is different, they will usually take the middle score. Either way, for a conventional mortgage from a private lender, you will need a credit score of at least 620.
What Other Factors Influence Lenders?
You can still be in the running for a home loan even if your credit score is below 620. On the other hand, you could find your application rejected with a 620+ score if other elements of your file raise red flags. Lenders look at a range of indicators in making a decision and use the combined data to establish the loan term, annual percentage rate (APR) and downpayment.
Home loan application factors
- Debt to income ratio (DTI). For a conventional mortgage, you would want to have a DTI no higher than 43% to reassure lenders that your debt burden is manageable now and in the future.
- Downpayment. For home loans backed by Fanny Mae and Freddie Mac, the convention is to make a downpayment of at least 20%. But that is by no means set in stone and many borrowers put down as little as 3%.
- Housing Cost Ratio (HCR). Ideally your HCR should be 28% or lower, meaning that your housing costs represent roughly a quarter of your available income. This is the benchmark for what is considered as affordable.
- Income. You could have a higher credit score but low or unstable income. Lenders want to see a consistent history of regular employment that puts your income above their threshold.
- Credit history. The more evidence you can supply of not just using your available credit but also paying off debts regularly and on time, the more likely lenders are to deliver a favorable decision.
The stronger and more thorough your credit portfolio, the more you can shift the borrower/lender relationship dynamics. With your best possible credit scores, credit history, downpayment and income you can attract competitive interest rates from lenders.
Creative Solutions for Lower Credit Scores
If your credit score is below 620, you will have to be more creative in your search. Luckily, conventional home loans are not the only type of borrowing. You could apply for a USDA or Federal Housing Administration (FHA) loan, for example. These are designed for lower-to-medium income borrowers or borrowers with bad credit, and offer loans starting from a minimum credit score of 500, with a down payment of as little as 3.5%. The availability of these loans operates on a sliding scale. If your score is below 580 but above 500, you will need to increase your downpayment to 10% as the maximum loan-to-value ratio is 90%.
Crucially, FHA-backed loans require you to take mortgage insurance, which means there will be upfront and annual premiums to pay. Mortgage insurance is also a common requirement on conventional loans where the downpayment is below 20%.
Although it might feel as if you’re submitting yourself to the whims of lenders, they are the ones competing for your business. To put yourself in the strongest position, start by checking that your credit report is error-free and fully up to date with our tools for borrowers. From there, you can make prudent decisions on building your score, managing your money, and building the habits to achieve your best score.
Sources
State of Michigan – Financial Future – Qualifying for a Mortgage
Investopedia – Federal Housing Administration (FHA) Loan Definition.
Bank of America – Mortgage, Refinance and Home Equity FAQs from Bank of America
Forbes – Mortgage Application Denied? Here’s What To Do