Your Mortgage Options According To Your Credit Score

Credit scores can be a confusing topic for even the most financially savvy consumers. Most people understand that a good credit score boosts your chances of qualifying for a mortgage because it shows the lender you’re likely to repay your loan on time. Since the beginning of the year, mortgage rates have risen, meaning that home loans are becoming more expensive. To stay on top of these increasing prices, it is more important than ever to maintain a healthy credit score because it could help you to secure lower interest rates. 

Your credit score is one of the most important factors lenders consider when you apply for a mortgage. Typically, the higher your score, the lower interest rates you’ll qualify for. 

Before you look at houses, check your credit score and pull your credit reports from the three major credit agencies. Addressing credit issues early on could help you raise your score before you apply for a mortgage or alter your methods to find the right mortgage options that are available to you. 

Is Your Mortgage Credit Score Lower Than You Think?

What may be surprising to many individuals is the range of low credit home loans that are available today. Most lenders will issue government-backed FHA loans and VA loans to borrowers with credit scores as low as 580. However, if your credit score is above 600, even more options may be available to you. Low-rate conventional mortgages only allow your credit score to lie around 620, and if your score is 680 or higher, you could apply for just about any home loan. 

Although it’s up to specific lenders to determine what score borrowers must have to be offered the lowest interest rates, sometimes even the difference of a few points on your credit score can substantially affect your monthly payments. If an individual can secure a loan if they have a lower credit score, the next question should be which mortgage option is best for varying credit scores. 

Though it is possible to get a mortgage with a low credit score, you’ll most likely pay higher interest rates and higher monthly payments. Lenders may be more strict about other aspects of your finances, such as how much debt you have. It is important to keep in mind that credit requirements vary from lender to lender. 

A Quick Summary of Typical Minimum Credit Scores for Different Loan Types: 

Conventional Loans: Many lenders will accept a credit score as low as 620 for conventional loans, but they may have other requirements for those borrowers, such as a higher income. 

Fannie Mae and Freddie Mac, the agencies that administer most of the conventional loans in the U.S., charge loan-level price adjustments, or LLPAs. 

The two factors that they base these fees on are: 

(1) Loan-To-Value (LTV): the ratio between the loan amount and the home value

(2) Credit Score

FHA Loans: The Federal Housing Administration guarantees loans for borrowers with tainted credit and low down payments. You can qualify for an FHA loan with a credit score of about 500-579 with a 10% down payment. Borrowers with a score of 580 can put down as little as 3.5%. 

Unlike conventional loans, FHA-backed mortgages don’t carry risk-based pricing, Risk-based pricing is a fee assessed to loan applications with lower credit scores or other less-than-ideal traits. Even if your credit score is less-than-desirable, there may be an increase in attention due to the interest rate, but a conventional loan will most likely offer the most success. For FHA-backed loans, this means that poor credit doesn’t necessarily equate to higher interest rates. 

USDA Loans: The U.S. Department of Agriculture backs the USDA loan program for low-to-moderate-income borrowers purchasing a home in a rural area. These types of loans are popular for their zero down payment requirement and low rates. Borrowers generally need a minimum score of 640 to qualify for a USDA loan. In some cases, USDA lenders will consider a lower score with additional analysis of a borrower’s credit. 

VA Loans: Backed by the U.S. Department of Veterans Affairs, VA loans are popular mortgage loans offered to active and veteran military personnel and their families. The government doesn’t have a minimum credit score requirement to qualify for VA loans, though many lenders require a minimum score of 620. 

With backing from the Department of Veterans Affairs, these loans do not require a down payment nor any ongoing mortgage insurance payments. In addition, these loans typically have the lowest interest rates on the market. Similar to FHA loan applicants, VA loan applicants with low credit scores can get similar rates to those who have high credit scores. 

What Else Do Mortgage Lenders Consider? 

Your credit score is a key factor in determining whether you qualify for a mortgage. But it isn’t the only thing that lenders consider. 

Income: Lenders will also look at your income. They want to make sure you make enough money each month to afford your payments. 

Debt-to-Income Ratio: Lenders also look at your monthly debts. Lenders vary, but they generally want your total monthly debts, including your estimated new mortgage payment. If your debt-to-income ratio is higher, you might struggle to qualify for a mortgage. 

Down Payment: The bigger your down payment, the more likely it is that you’ll qualify for a mortgage with a lower interest rate. That’s because lenders think you are less likely to stop making your payments if you’ve already invested a significant amount of money into your loan. A higher down payment makes your loan less risky for lenders. 

Savings: Lenders want to make sure that you have funds available to make your mortgage payment if your income should unexpectedly dry up. Because of this, most will want to see that you have enough money saved to cover at least two months of mortgage payments. 

Employment History: Lenders vary, but they usually like to see that you’ve worked at the same job, or in the same industry, for at least 2 years. They believe you’re less likely to lose that job, and that stream of income, if you’ve built up a longer work history. 

So What Does All This Mean? 

Before shopping for a house, you may want to take a look at your credit score. Making moves to increase your score, like checking your credit reports for errors, lowering your debt utilization by paying off your credit card balances in full each month, and making all of your payments on time, could help you boost your score before applying for a loan. Even if you can’t lock in that perfect score, just a few points can push you into the next underwriting level for somewhat lower rates. And that small change could save you thousands over time.