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Your credit score is a huge factor when you buy a house. Mortgage lenders and banks use it when considering what loan you may qualify for — or whether you’ll qualify at all.
So what is a good enough credit score to buy a house?
It’s not so much that you need a certain score. It’s more important to know how your score will affect the rate, loan amount, and down payment you’ll be asked for.
What’s more, the standards of mortgage lenders aren’t the same as they were before the COVID-19 pandemic. Many are asking for higher credit scores and bigger down payments. Overall credit availability dropped in both March and April, according to an April report from the Mortgage Bankers Association, an industry trade group.
“Credit standards are tightening because the economic landscape is changing so quickly,” says Greg McBride, CFA, chief financial analyst for Bankrate.com.
Whether you’re looking to buy a house in the next few months or the next few years, the benefits of checking in on your credit score — and taking steps to improve it — will pay off in the long run.
Minimum Credit Score by Loan Type
Conventional loans are backed by individual private mortgage lenders instead of the federal government, so eligibility requirements vary from lender to lender. Loans backed by Fannie Mae and Freddie Mac require a minimum credit score of 620, although individual mortgage lenders are free to require a higher score at their discretion. Conventional mortgages generally have stricter requirements — in terms of credit score as well as other factors like debt-to-income ratio and employment history — than government-backed loans, so you’ll likely need a higher credit score than the minimum.
For FHA loans, the minimum credit score is 500, but that comes at a catch — you’ll have to put 10% down, as opposed to the 3.5% down payment of a typical FHA loan. To have the option for maximum financing (3.5% down payment), you’ll need a credit score above 580.
VA Loans, which are only available to qualified veterans, service members, and certain surviving spouses of veterans, don’t have a minimum credit score requirement. Instead, the VA requires lenders to “review the entire loan profile.”
USDA Loans, which are offered to low-and moderate-income borrowers buying homes in rural and suburban areas, also do not require a certain credit score. But applicants need to “demonstrate a willingness and ability to handle and manage debt,” and having a good credit score is one key factor of that. You’ll likely want a credit score of 640 or higher.
|Loan Type||Minimum Credit Score|
|Conventional Loan||620, may be higher depending on lender|
|FHA Loan||500 for 90% financing (10% down)|
580 for maximum financing (3.5% down)
Going beyond whether you qualify for a loan, your credit score will have a significant influence on your mortgage’s interest rates, and therefore the monthly payments you’ll make. The chart below shows how a range of scores might affect the payments on a 30-year fixed-rate mortgage.
|FICO SCORE RANGE||620-639||640-659||660-679||680-699||700-759||760-850|
|$200,000 loan||$984||$921||$873||$84 9||$830||$807|
*Based on national mortgage rates as of February 25, 2021
What Factors go Into a Credit Score?
- Payment history. Lenders want to see that you have a history of making consistent and on-time payments. Any missed or late payments or insufficient payments will appear as a negative mark on your credit report. Make sure to always pay your bills on time and in full if you’re able. This factor has the biggest impact on your credit score, accounting for 35% of the calculation.
- Balances owed. Also known as your credit utilization ratio, this is calculated by dividing all your debts by the amount of credit available to you. Try to keep it under 30% to have the best credit score. This is the second most important factor in determining your credit score, at 30%.
- Age of credit history. This is the average of how long each of your credit accounts has been open. Try not to close old accounts, even if you’re not using them anymore, or else it might hurt your age of credit history. This factor accounts for 15% of your credit score.
- Credit mix. This is how many types of credit you have. Lenders generally want to see a diverse mix of installment credit, revolving credit, and open credit to show that you can handle multiple types of credit responsibly. Credit mix accounts for 10% of your credit score.
- Recent Activity: This factor looks at recent activities on your credit accounts. A lot of credit inquiries in a short period of time can hurt your score, so avoid applying for too many new accounts at once. The factor counts for 10% of your credit score.
To access your credit score, check your credit card statement or online bank account. If you can’t find it, use the help feature on the bank or issuer’s website to get assistance. Some services can also provide you with your credit score for a fee.
What Else Do Mortgage Lenders Consider?
Your credit score is important, but it’s not the only factor used to evaluate you. Here are some of the most common things that lenders will look at when determining your creditworthiness.
- DTI ratio. Debt-to-income ratio (DTI) is calculated by taking all your debt obligations and dividing that number by your gross income. “This is important because it will show how much debt you are capable of handling,” says Molly Ford-Coates, president of Ford Financial Management LLC, an online financial counseling agency. “Including housing expenses, this ratio should not exceed 35% of your gross income.”
- How much credit you’re using. The amount of credit you’re using also plays a role in your credit scoring. Similar to DTI, this ratio calculates the amount of debt you’re currently carrying compared to your available credit line — or if, it’s a car or student loan, the amount of the original balance. For this reason, any long-term debts you can clear up before you meet with your mortgage lender will play a role in determining how much you’re able to borrow.
- Employment history. Although your employment history isn’t part of your credit score, it is an important element of your mortgage application, says Andrew Helling, a real estate agent and editor of REthority.com, a website specializing in real estate content. “Lenders typically seek at least two years of employment history, though it’s not necessary to be at the same employer for those two years.” If you’re self-employed, you’ll need two years of steady income reported on your tax return to appeal to a lender.
- Down payment amount. A good rule of thumb is to put down 20% of the purchase price as your down payment. People who put down 20% “will get more favorable terms, including lower interest rates and even a lower loan origination fee,” Helling says. With lenders more strict on who they approve for a loan, 20% may be less of a rule of thumb and more of a requirement. Those who can’t put down 20% but still qualify for a mortgage could add private mortgage insurance (PMI) to their loan, but it’s an additional cost that needs to be weighed against your budget and goals.
What’s The Best Way To Improve Your Credit?
Whether you have a credit score of 850 or 550, there are several steps you can take to prepare yourself to meet with a mortgage lender as you begin your search for a new home. Improving your credit isn’t a one-and-done project but rather something you can and should be doing at all times to be better prepared for significant purchases.
Pay down long-term debt
If you can pay down any long-standing debts, such as student loans or car loans, before you meet with your mortgage lender, it’s a good idea to do so. For one thing, it’s one less headache to worry about. For another, by closing out debt, you’re making it clear to your lender you have no problems with making monthly payments. “By paying down a car loan on time, you’re showing the bank you are a responsible borrower,” Helling says.
Pay more than monthly minimums
If you’ve maxed out your credit card in the past, now is the time to take control of the situation. “Make more than the minimum payment due each month,” says Lisa Torelli-Sauer, editor at Sensible Digs, a website specializing in budgeting home investments. “Even if it’s only a few dollars more than the minimum payment, it will show the credit reporting agencies you are making a greater effort to pay down your debt and will improve your score.”
Don’t close out paid-up credit cards
Another tactic to help convince lenders you’re a good risk, says Torelli-Sauer, is keeping credit accounts open after you’ve paid them off, even if you don’t plan to use them anymore. “A long-standing loan or line of credit shows a positive consumer-lender relationship and improves your credit score. Even if you pay off your credit card or line of credit, don’t close it. The longer it’s listed on your credit report, the more it will help your credit score.”
Monitor your credit reports
Each year, you’re entitled to one free credit report from each of the “Big Three” credit bureaus — Experian, Equifax, and Transunion. And in light of the pandemic, you can view your report for free weekly through April 2021. It can pay off big time to get those reports and read them carefully, according to Karra Kingston, a New York bankruptcy lawyer. Why? Because even credit bureaus make mistakes, and a mistake on your credit report could cost you a mortgage. “You should always be up-to-date on what has changed and why something has changed,” Kingston says.
The bureaus make it possible to fix errors in your reports with online forms you can fill out and submit. There are also a number of for-profit companies that will monitor your credit and alert you if there are significant changes, but in most cases, you’ll be able to do this monitoring yourself for free.
Be fiscally conservative
If you’re planning on applying for a mortgage in the near future, now isn’t the right time to splurge on that great stereo system you’ve been eyeing or open a new credit card account, says Matthew Martinez, an investment real estate broker and certified property manager with Diamond Real Estate Group, based in the San Francisco Bay area. “It’s a good idea to cut your spending, decrease your debts, and avoid hard credit inquiries and big purchases when you’re getting ready to purchase a home,” he says. Hard credit inquiries are made by financial institutions when they check your credit before you apply for a loan or credit card. Your consent is required, and the inquiry is included in your credit report and can affect your final score.
Keep everything organized
This matters more than you might think, Helling says. Lending agents, after all, are only human. Suppose you show up at a mortgage meeting with slips of disorganized financial information sticking out of envelopes and overflowing from your briefcase. They may question your ability to pay back a loan in a timely manner. “Lenders have a lot of paperwork to get through, and giving them an organized list of income, expenses, and more will help expedite their approval process. Consider your documentation a road map of your finances,” Helling says.
Why This Is Important
Each lender has its own formula for determining where the cutoff point is in a credit score. As the experts will tell you, the better your credit rating, the more likely you are to get a low-interest rate and favorable terms when you apply for a mortgage. Someone with a credit score of 850 is very likely to find they will pay less per month than someone with a comparably priced home but a lower score of 680.
Take steps to improve your credit score. Improving your score will help you thrive financially when you find the house of your dreams. If you are credit-ready, don’t let the news of higher credit standards scare you from buying now. No one knows if, or when, lending standards will change again. These standards may be the new normal.