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How Credit Scores Affect Purchasing a House

How Credit Scores Affect Purchasing a House

Underwriting a mortgage is a complicated process. The three "C's" are a steadfast standard. Credit, Capacity to pay, and Collateral work in unison to approve a loan of any type.

Credit score will be the first determination in the home buying process. Not only does your FICO score determine if you can qualify for a loan in the first place, it will also have an impact on your mortgage terms.

What credit score means to the lender.

You don't need flawless credit to get a mortgage. In some cases, scores can even be in the 500s. But because credit scores estimate the risk that you will not repay the loan, potential lenders will reward a higher score with more choices and lower interest rates.

For most loan types, the credit score needed to buy a house is at least 620. But higher is better, and borrowers with scores of 740 or more will get the lowest interest rates.

Conventional loan: 620

Though you may be able to get a conventional loan with a credit score as low as 620, these mortgages often require higher scores. FICO scores for home buyers using conventional loans average around 760.

A higher score also earns a break in the cost of private mortgage insurance, or PMI, which is required with a down payment of less than 20% on a conventional loan. With a 10% down payment, a 620 borrower will pay approximately 1.1% in PMI. A 760 FICO borrower would pay just 0.30%.

FHA loan: 500

If you have a credit score in the 500s, your best chance for a home loan will be one insured by the Federal Housing Administration.  FHA loans allow down payments as low as 3.5%, but to qualify, you'll need a FICO score of 580 or better. With a credit rating of 500 to 579, you will be required to make a 10% down payment.

That said, lenders can impose their own credit minimums for FHA loans. The average FICO score for home buyers with FHA loans is about 680. Even lenders that are willing to take on a borrower with a credit score that is under 600 will want to see that other aspects of your financial situation are secure.

A borrower with a 500 credit score is likely to have some combination of collection accounts, liens and judgments. Even though FHA will insure a loan with a 500 score, the lender will require that collections, judgments and most liens be paid off before closing.

VA loan: 640

Mortgages guaranteed by the Department of Veterans Affairs, better known as VA loans, do not have a government-set minimum credit score to buy a house. Their main qualification is that you be a veteran, an active-duty member of the military or an eligible spouse.

That said, VA lenders choose their own minimum credit scores. These vary, but are generally in the low to mid-600s.

USDA loan: 640

Like VA loans, home loans from the U.S. Department of Agriculture do not have a set minimum credit score and lenders can require their own score minimums. But if your score is over 640, you could be eligible for streamlined credit processing on a USDA loan.

Jumbo loan: 700

In order to get a mortgage that's larger than the conforming loan limit better known as a jumbo loan most lenders will want to see a credit score that's north of 700 or even 720. Because lending that much money is inherently risky, lenders look for potential home buyers to have solid financials, including a strong credit score.

With a FICO score of 740 or higher, you are likely to get the best jumbo mortgage rates. Using a mortgage calculator can make clear how even a slightly lower rate can make a big difference.

Less than stellar credit scores and buying a house.

Having bad credit or no credit may mean you are unlikely to get a mortgage unless someone you know is willing to help out. Having a co-signer who has a better credit score could help you secure the loan.

Another option would be to have a friend or more likely a family member purchase the home, add you to the title and then try to refinance into your name when your credit scores improve sufficiently.

If such assistance isn't available to you, your best bet will be waiting and working on your credit.

Strengthen your credit score to buy a house.

If your score doesn't qualify for a great rate or the type of mortgage you'd prefer, it might make sense to put off home buying for a while and use the time to build your credit profile. Here's how:

  • Maintain low credit card balances: Experts recommend you use no more than 30% of the limit on any credit card, and much lower is much better. How much of your available credit you are using is called your credit utilization, and it's the second-biggest factor in your score.

  • Check your credit reports: Look for score-lowering errors. If you find something, dispute it. Through April 2021, you are entitled to at least one free credit report from each of the three credit bureaus, Experian, Equifax and TransUnion, every week.

  • Keep credit cards open: Closing a card reduces the amount of available credit you have, which can send your credit utilization up and ding your score. Make a charge occasionally and pay it off promptly; that keeps the issuer from closing your account for inactivity.

  • Look at your credit mix: If you have only credit cards or only installment loans, consider adding the other type so you can demonstrate a good payment record across diverse credit lines. If you are trying to build up a thin credit file, you could consider a secured credit card or a credit-builder loan.

Your credit and monitoring your progress.

While you're working your way toward the credit score needed to buy a house, check your progress with a free score; some credit cards and many personal finance websites offer them. (NerdWallet offers a free credit score that updates weekly.)

Free credit scores often are VantageScores, a competitor to FICO. Either type of score can be used to track your progress as they both emphasize the same factors, with slight differences in weighting, so they tend to move in tandem.

Mortgage lenders check older versions of the FICO score (FICO 2, 4 and 5). If you want to see where you stand on those so you know exactly what mortgage lenders will see, you will have to purchase a comprehensive FICO report. You can do that at myFICO.com, then cancel the monthly service rather than pay an ongoing fee. Be sure to cancel before the next billing cycle starts; the monthly subscription fee will not be prorated.

However, if you are near or in the excellent credit score range on a free score source, you do not need to pay to check your FICO scores. You almost certainly have good enough credit to qualify for the best rates.