When you apply for a mortgage, the lender will evaluate several factors to determine if you’re a good candidate for funding. One of the more significant factors is your credit score, which demonstrates how you’ve managed debt obligations in the past. The minimum credit score you’ll need varies by the home loan product you select, and some lenders impose overlays or more stringent guidelines that make it harder to qualify for funding.
So, before you start shopping for a new place, familiarize yourself with the credit score criteria to avoid any surprises. It’s equally important to know what else lenders consider when deciding if you’re a good fit for a home loan.
Why Mortgage Lenders Look at Your Credit Score
Your credit score paints a picture of how you’ve handled debt in the past. It ranges from 300 to 850 – the higher, the better – and predicts the likelihood of default.
Mortgages are generally for large amounts, which means the risk of loss to the lender is significant even though the loan is secured by the property. So, the lender wants reassurance that you’ll make timely monthly mortgage payments. If not, they’ll either charge you far more to borrow the funds and minimize risk or deny you a home loan altogether. And a higher interest rate means your monthly payment will increase, and you’ll pay more in interest over the life of the loan.
To illustrate, assume you’re seeking a fixed-rate 30-year $375,000 home loan. If you have good credit and the lender offers you an interest rate of 6.5 percent, your monthly payment will be $2,370 (principal and interest only). Plus, you’ll pay $478,482 in interest over the loan term, bringing the total cost of the loan to $853,482.
But if you’re unable to improve your credit score and qualify for a 7 percent interest rate, you’ll get a slightly higher monthly payment of $2,494. However, the total interest paid will increase to $523,919, and the total cost of the loan will be $898,919. That’s a significant difference for a slight difference in the interest rate.
Credit Items That Most Lenders Consider
Before taking a look at the credit score you’ll need to qualify for a mortgage, you should know which items matter most to lenders.
Many borrowers focus solely on their credit score when looking to apply for a mortgage. But your credit reports are equally important as they contain the information used to calculate your credit score. Furthermore, lenders also look at your credit history to gauge if you’ve responsibly managed debt obligations over time or if there are adverse credit items that indicate financial missteps.
FICO Scores, which are used by most lenders and creditors to make lending decisions, are computed as follows:
- Payment history: 35 percent of your FICO score
- Amounts owed: 30 percent of your FICO score
- Length of credit history: 15 percent of your FICO score
- Credit mix: 10 percent of your FICO score
- New credit: 10 percent of your FICO score
When reviewing your credit reports from the three major credit bureaus – Experian, TransUnion and Equifax – make a note of any errors and file disputes promptly (if applicable). Otherwise, inaccurate information could continue dragging your credit score down and not give the lender an accurate picture of how you’ve managed credit over time.
Timeliness of Payments
Recent late payments on debt accounts are a major red flag for lenders. But if it’s been some time since you’ve fallen behind on payments – ideally two years or more – you could be approved for a mortgage, assuming you meet the lender’s other eligibility guidelines.
Derogatory credit items, like collection accounts, charge-offs, bankruptcies and foreclosures, aren’t necessarily deal breakers when it comes to getting approved for a mortgage. However, they shouldn’t be recent, and the lender will likely want an explanation of the events before making a loan decision.
Does Your Credit Score Affect Mortgage Rates?
A lower credit score signals to the lender you’re new to credit or have had some trouble paying bills on time in the past. Consequently, they want to protect their interests if they decide to lend to you, typically in the form of higher borrowing costs.
Minimum Credit Score to Buy House
Below, you’ll find the minimum credit score requirements by home loan type. Be sure to use this list as a general guide, as some lenders have overlays or stricter guidelines for the minimum score they’ll accept, as mentioned above.
Also, keep in mind that lenders pull your credit scores from the three major credit reporting agencies – Experian, TransUnion and Equifax – and use the middle score when reviewing your loan application. So, if your scores are 740, 680 and 710, the lender will use 710 to determine your eligibility for a home loan.
A credit score of at least 620 is needed to qualify for a conventional loan. However, you should aim for a higher score before applying since these loans are ideal for borrowers with good or excellent credit. So, a lower credit score means you could be eligible but can expect higher borrowing costs.
FHA loans are backed by the federal government and cater to credit-challenged borrowers or lower-income individuals. The minimum allowable credit score for an FHA loan through most borrowers is 580, and you’ll need a 3.5 percent down payment. That said, there are lenders who extend FHA loans to borrowers with credit scores between 500 and 579, but you’ll need a down payment of at least 10 percent.
VA loans, which are insured by the Department of Veteran Affairs, do not have a preset minimum credit score requirement. Still, most lenders have a threshold to determine which candidates are eligible for funding. For example, a credit score as low as 580 is acceptable in some instances, but a 640 or higher will open the door to more funding opportunities.
USDA loans are reserved for borrowers looking to purchase in qualifying rural areas. You’ll need a credit score of at least 640 with most lenders to qualify for a mortgage. However, be mindful that you could be eligible with a lower credit score assuming there are other compensating factors, like a lower debt-to-income ratio.
Jumbo loans are mortgages that do not conform to the limits set by the Federal Housing Finance Agency (FHFA). In most areas, it’s $726,200 or $1,089,300 for high-cost areas. You’ll generally need a credit score above 700 to be considered for a jumbo loan.
What Other Factors Do Lenders Look At?
Your debt-to-income (DTI) ratio is the percentage of your gross monthly earnings that are used to make minimum monthly debt payments. To illustrate, if you earn $6,500 per month and your payments are $3,000, your DTI is 46 percent (or $3,000 / $6,500). Try to keep this number below 50 percent to have the best chance of getting approved for a mortgage with competitive terms.
Your loan-to-value (LTV) ratio is the percentage of the home’s purchase price that you borrow. For example, if the home sells for $300,000 and you take out a loan for $291,000, your LTV is 97 percent (or $291,000 / $300,000). The acceptable LTV varies by the lender and loan program you select. Keep in mind that an LTV above 80 percent likely means you’ll pay mortgage insurance.
Income and Other Assets
Most mortgage lenders want proof of employment and earnings for at least two years. You could also be required to have between three and 12 months of reserves (equal to your monthly mortgage payments) on hand before the lender will approve you for a loan.
Get a Mortgage with Minimal or No Credit Requirements
Whether you have stellar or less-than-perfect credit, you could still be eligible for a home loan. Consider a lender like Angel Oak Mortgage Solutions when you’re ready to start shopping for a home loan with competitive terms that fits your needs and budget.
Its suite of innovative mortgage products is flexible and gives prospective buyers the opportunity to expand their real estate portfolios or make their home ownership dreams a reality. You could be eligible for a non-traditional mortgage, like a bank statement home loan, business elite home loan or jumbo home loan. Or you could go the traditional route with a conventional home loan, FHA home loan, VA home loan or USDA home loan.
Visit the website today and complete the online form. You’ll be connected with a Licensed Mortgage Professional from the Angel Oak Mortgage Solutions team who can assist with your next home purchase.