What Credit Score Do You Need to Buy a House?
Your credit score is a significant factor when it comes to buying a house. In addition to dictating whether you're eligible for a mortgage, your score plays a big role in determining what kind of interest rate and other terms you receive.
What factors determine your credit score?
Over 90 percent of banks use the FICO credit scoring model, so it makes sense to look at how your FICO score is calculated. Your credit score is made up of five factors, each of which carries different weight.
Payment history (35%) - Payment history is the most important factor, making up 35 percent of your credit score. This shows whether you pay your bills on time, as well as how often you run late on a payment or miss it altogether.
Credit utilization (30%) - Your credit utilization is the ratio between how much available credit you have and how much you're currently using. It's best to keep this number below 30 percent.
Credit history (15%) - This is a measure of how long you've used credit. If you're new to the world of credit, this factor can pull down your score.
Credit mix (10%) - Credit mix makes up 10 percent of your credit score. It's good to have a mix of various credit types, but you shouldn't take on new credit just for the sake of improving your score.
New credit (10%) - New credit accounts for 10 percent of your score. Soft inquiries don't affect your score, but having too many hard inquiries on your credit report can damage your score.
What credit score is needed to buy a house?
The credit score you need to buy a house will depend on your lender's requirements. As a general rule, however, a score of 700 or higher means you're likely to get approved for a loan.
As you sink into the 600s, however, you might find it more difficult to get approved, and you might get offered less than favorable interest rates. Depending on the lender, anything below 640 or 620 will make you ineligible for a conventional fixed rate home loan.
However, certain programs accept lower credit scores for government-sponsored mortgages. For example, FHA loans and VA home loans are usually open to buyers with lower credit scores.
Minimum credit score by mortgage loan type
Your mortgage options will depend on several factors, including your income and credit score. Here's a breakdown of mortgage options based on credit scores.
Conventional mortgage: 700 to 740+
If your credit score is 740 or above, you can probably count on getting a conventional mortgage with the best interest rates available. The long-term borrowing costs is typically lower on a conventional home loan.
Also, borrowers with credit scores in this range can usually forego private mortgage insurance (PMI). You can get out of paying PMI if you make a down payment of at least 20 percent.
If your credit score falls between 700 and 739, you're still likely to get a good interest rate on a conventional mortgage, but you might have to shop around a bit more.
With a credit score in the 700 to 740+ range, you might also qualify for a jumbo mortgage, which is a conventional mortgage with a non-conforming loan limit. These types of mortgages let you borrow enough money to purchase a home in a high-cost living area.
Government program mortgages: 500 to 699
While the federal government doesn't actually lend money to homebuyers, several federal agencies back mortgages through special programs. With a credit score ranging between 500 and 699, you might qualify for a variety of home loans through the U.S. Department of Agriculture (USDA), Department of Veterans Affairs (VA), or the Federal Housing Administration (FHA).
USDA loans - USDA loans are geared toward borrowers with low to moderate incomes who wish to buy a home in a rural area. Eligibility criteria vary by state and county, and borrowers must meet income requirements.
VA loans - Active, reserve, national guard, and veteran members of the armed forces and their spouses may qualify for a mortgage through the Department of Veterans Affairs. VA loans generally have more flexible eligibility criteria when it comes to credit scores, as the VA doesn't have a minimum credit score requirement. However, because VA loans are administered by banks, so borrowers will still need to satisfy their lender's credit score requirements. On the plus side, VA loans require no down payment and no PMI.
FHA loans - Borrowers with credit scores as low as 500 may qualify for an FHA loan. The FHA, which is part of the Department of Housing and Urban Development (HUD), backs loans for borrowers who don't have the down payment required for a conventional mortgage.To get an FHA loan for 96.5 of the purchase price with a 3.5 percent down payment, you'll need a credit score of at least 580. Borrowers with a 500 credit score must come up with at least 10 percent for a down payment.
Limited mortgage options: 300 to 499
Borrowers with credit scores between 300 and 499 will struggle to qualify for a mortgage. If your score falls in this range, your best bet is probably a cosigner.
However, acting as a cosigner a mortgage can be a risky proposition. For example, if you ask your parents to help you get a mortgage, they will be responsible for your home loan but won't actually get any rights to the property.
In other words, a cosigner takes on all of the risk for none of the benefits of home ownership. If you default, your cosigner is on the hook for the balance of the mortgage.
Do credit scores affect mortgage rates?
Your credit score affects your mortgage rate in more ways than you might realize. Here are four ways your score can influence the rate you receive.
When banks consider someone for a loan, they assess what kind of risk that person poses with respect to default. If someone has a low credit score, this assessment assumes the person is more likely to default.
You can see how risk-based pricing affects you by comparing the rates between two credit scores. For example, consider a borrower with a 625 credit score versus someone whose score is 750.
The borrower with a 750 score will get a better interest rate. Even if the rate is just half a percent better, this can make a significant difference in the cost of the loan.
Assume, then, that the 750 score borrower gets a $200,000 loan for 30 years at 3.625% interest. This makes their mortgage $912 a month.
By contrast, the borrower whose score is 625 qualifies for a $200,000 loan over 30 years at 4.125% interest. This makes their mortgage payment $969 a month.
The difference between the two payments is $57 each month, which might not seem like much at first. When you multiply it over 30 years, however, the borrower with the lower credit score ends up paying $20,520 more for their mortgage.
Loan-to-value (LTV) ratio is a figure banks use to decide the level of risk associated with a loan, including mortgages. This number is a measure of the loan amount versus the property's market value.
You can calculate LTV as follows: (loan amount ÷ property value) x 100. For example, if you're asking for a $250,000 loan on a house valued at $300,000, your LTV is 83.3%.
Many lenders put limits on LTV when borrowers' credit scores fall below a specific number. Generally, the better your credit score, the more a lender is willing to let you borrow.
For instance, someone with a 750 credit score might be able to get a mortgage for up to 95 percent of the home's value, while a borrower with a 650 score might only be able to borrow up to 80 percent of the property's value.
Private mortgage insurance (PMI)
Your credit score can also determine whether you pay PMI, which can increase the cost of your loan. Generally, banks require PMI any time a borrower's down payment is less than 20 percent.
PMI protects lenders in case the borrower defaults, so the insurance companies that underwrite these policies look at borrowers' credit history when determining the cost. The lower your credit score, the more you will pay in PMI, adding hundreds or even thousands of dollars to your loan each year.
Compensating for other factors
Banks look at a number of factors when deciding whether to approve someone for a loan. In addition to credit history, they also review your income, debts, and down payment.
If you're weak in one area, strength in other areas might help tip you toward approval. For example, a large annual income could make up for a lower credit score or a modest down payment.
Can you buy a house with bad credit?
Even with bad credit, you may still be able to buy a house. While you might struggle to get approved if your credit score is below 500, some lenders are willing to work with borrowers whose scores are 500 and above.
However, a score in the 500s means you will almost certainly end up with a subprime mortgage. These types of mortgages come with high interest rates and extra fees, which will cost you more over the life of your loan.
Basically, your chances of getting a home loan come down to risk. When banks get a mortgage application, they assign the borrower a grade that is a reflection of the borrower's risk.
These grades range from A to D, with an "A-paper" grade being the lowest risk. Mortgage applicants who get an A-paper grade are considered "prime" borrowers and they typically have the following:
680+ credit score
Debt-to-income ratio that doesn't exceed 35%
Minimum 20% down payment
Borrowers who receive grades of B, C, or D are subprime borrowers who receive subprime mortgage rates on home loans. However, someone who receives a B-paper grade is considered less risky than a C or D borrower.
6 fast ways to raise your credit score before applying for a mortgage
If you're in the market for a new home, there are things you can do to boost your credit score before you apply for a loan. Here are six strategies to consider.
1. Check your credit report and dispute errors
A study from the Federal Trade Commission (FTC) found that 1 in 5 consumers has at least one error on their credit report. Before applying for a mortgage, you should thoroughly review your credit report to make sure everything is accurate.
2. Pay off debt
Banks look at your debt-to-income ratio as part of the mortgage approval process. Before they give you money to buy a house, they want to know how much of your income is spent paying off debts each month.
You can improve your debt-to-income ratio by reducing your debt. For example, some people like to use the snowball debt repayment method, which involves picking your debt with the lowest balance and then working to pay it off as quickly as possible.
Once you pay off that debt, you move to the next largest balance and pay it off as fast as you can. The idea is to pick up momentum, paying off larger and larger debts like a snowball rolling downhill.
You may also be able to improve your credit score by settling an old debt or paying a delinquent account. In fact, your mortgage lender may insist on this before approving your loan.
3. Request a credit limit increase
You can improve your credit utilization by asking your creditors for additional credit. Most lenders want to see credit utilization below 30 percent, as it shows you don't need to rely on credit to meet your ordinary financial obligations.
4. Become an authorized user
If you have less than perfect credit, you can piggyback on someone else's excellent credit by having them add you to their account as an authorized user. For example, you could ask a relative or close friend to add you to their credit card.
Before you do this, however, make sure the creditor reports authorized user activity to the credit bureaus. You don't necessarily need to use the credit card to benefit from the primary account holder's good payment history.
5. Take out a credit builder loan
A credit builder loan lets you pay yourself to improve your credit score. Unlike a traditional loan that gives you money up front, a credit builder loan works in reverse.
With a credit builder loan, you make monthly payments that are deposited into a type of savings account. As you make your payments each month, the bank reports your payment activity to the credit bureaus.
At the end of the loan term, you get the full loan amount plus any interest. Credit builder loans are good for people with bad credit or no credit history.
6. Ask for a rapid rescore
If you've taken steps to improve your credit, you can ask for a rapid rescore to see if your efforts are reflected in your score. Most mortgage lenders offer simulations that predict how much rapid rescoring will help your score.
Financial tips to prepare you for buying a house
For many people, a house is the biggest purchase they will ever make. When you're investing that much money in something, you want to make sure you get the best loan offer possible.
Before you shop for a mortgage, it pays to do some financial prepwork ahead of time. Here are some steps you can take to get your finances in order.
Pay your bills on time - Your payment history accounts for 35 percent of your credit score. Paying your bills on time is one of the most important things you can do to improve your score.
Don't close old credit cards - Unless a card has a high annual fee, try to keep your credit card accounts open, even if you no longer use the card. This helps you maintain important credit history, which helps your credit score.
Avoid carrying a credit card balance - Credit cards are an important tool for building credit, but they can also hurt your credit if you keep a high balance. If possible, make purchases on your credit cards and then pay them off completely each month.
Don't take on too much new credit - Be careful about submitting credit card applications or applying for other forms of credit. This can add hard inquiries to your credit report, and too many inquiries will lower your score.
Monitor your credit - Federal law entitles you to one free credit report from all three major credit bureaus every 12 months. You can also check your credit score for free by signing up for the Discover Credit Scorecard.
Your credit score can make or break a mortgage application. If home ownership is one of your dreams, it's never too soon to start improving your credit.
About the Author
Mike is a recognized credit expert and founder of Credit Takeoff. His credit advice has been featured in CNBC, Investopedia, CreditCards.com, Bankrate, Huffpost, The Simple Dollar, Reader's Digest, LendingTree, and Quickbooks. Read more.