How High Should My Credit Score Be in Order to Buy a Home?
A home, financial experts say with good reason, is one’s best investment. Homes secure and protect us while giving us comfort, identity, and place. They also appreciate in value when properly managed. A home can be such a good investment that it is one of the few investments financial advisors will recommend borrowing to purchase. Indeed, very few of us can pay cash for a home, making borrowing a necessity. In order to borrow money to buy a home, you’ll need a strong credit score – but how high does it need to be?
Good Credit Score to Buy a House
Borrowing to buy a home depends on qualifying for the mortgage loan. Qualifying for a mortgage loan can depend on several factors like one’s income, employment history, debt-to-income ratio, savings or investments, down payment, and credit score. Banks must be responsible with their loans, ensuring reasonable prospects for repayment. Among the several factors, credit score, also known as a FICO score for the analytics company Fair Isaac Corporation popularizing the number, is the primary way banks qualify borrowers for mortgage loans.
FICO or credit scores depend on your credit history, not on how much you earn or your net worth. Generally, a FICO score of 800 or above is exceptional, above 740 very good, above 670 good, and above 580 fair. The formula determining your FICO score weights your payment history at 35% of the score, the debt you owe at 30%, duration of credit history at 15%, new credit extended at 10%, and credit mix at 10%. A score above 700 will help you to buy a house, although loan terms may improve for scores up to 740.
Minimum Credit Score to Buy a House
Generally, the lowest credit score to buy a house is 500. Borrowers typically need a certain credit score to qualify for a mortgage loan, although that minimum credit score varies depending on the type of mortgage loan. You may not qualify for one type of loan but may qualify for a less-attractive loan type, depending on your credit score. Different mortgage loans require different minimum credit scores. While minimum scores can vary depending on other factors, these minimum scores would apply to typical borrowers:
- for Federal Housing Administration-insured loans made to low-to-moderate-income borrowers, the minimum credit score is 500 if the down payment is the preferred 10% but 580 if the down payment is the minimum 3.5%;
- for S. Department of Agriculture-guaranteed loans also made to low-to-moderate-income borrowers, but for rural development, the minimum credit score is typically 580 but may be lower in special situations;
- S. Department of Veteran Affairs-insured loans made to qualifying military members and veterans and their family members do not have a regulatory minimum credit score, but banks offering these loans tend to require a credit score of at least 620;
- for conventional mortgage loans meeting the secondary-mortgage-market standards of the government-sponsored Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac), banks tend to require a credit score of at least 620, although some conventional loans require a 660 score or higher;
- for jumbo loans of $548,250 or more (or a higher minimum of $822,375 in some high-cost markets), banks tend to require a credit score of 700 or higher.
Better Scores Can Mean Better Terms
The question, though, isn’t simply whether you can get a mortgage loan. The question is about getting a mortgage loan on the best terms. Lenders tend to offer better loan terms to borrowers with better credit scores because their risk of non-payment is lower. Pay attention to your credit score, and you may get better loan terms. As indicated above, loan terms may improve for a credit score up to around 740.
What do better terms mean? The higher your credit score, the better your chance of getting a lower interest rate. A swing of as little as 120 points in your FICO score can mean as much as a 1.5% difference in your mortgage loan’s interest rate. That small increase in interest rates can mean a significantly higher monthly payment. A 1.5% increase in interest rate can mean a $200 increase in monthly loan payments on a 30-year mortgage of just over $200,000.
A small rise in the interest rate can also mean tens of thousands of dollars more paid in total interest over the loan’s life over the life of a mortgage loan. That same 1.5% increase in interest rates can mean nearly a $50,000 difference in total interest payments over the 30-year life of that $200,000-plus loan. Use the Consumer Financial Protection Bureau’s online tool to estimate the effect of credit scores on mortgage loans of different types in various amounts in different states.
Your loan’s interest rate is a key indicator of the wisdom of your home investment. Generally, the higher your interest rate, the less good the investment in your home represents. It also leaves less for you to spend on other needs or save for other investments. The lower your interest rate, the better your investment, all other things (such as loan duration) being equal. Generally, you want the lowest interest rate for which you can qualify, although the loan’s duration also impacts the total amount of interest you will pay. The shorter the duration, say 15 years instead of 30 years, the less total interest you will pay, even though your monthly payment will generally be higher.
How to Buy a House When You Have a Bad Credit
Sometimes, though, getting into a home can still make great sense, even if you have a poor credit score. Depending on your real estate market, owning a home and paying for the mortgage may cost you less than renting the same home. And your first mortgage loan will probably not be your last. Improved earnings and finances, and the improved credit score that should come with them, may soon qualify you for refinancing your mortgage on better terms.
Indeed, all may not be lost if your credit score does not qualify you for the conventional mortgage loan for which you first applied, generally requiring at least a 620 score. You may need to apply for an FHA-insured or USDA-insured loan, where lower 500 or 580 credit scores can qualify. If those federally-backed loans are not available to you, then you may still have these options to get a mortgage loan despite poor credit:
- save more money for your down payment;
- acquire more money for your down payment by a gift from family members;
- increase your income to lower your debt-to-income ratio;
- decrease your debt to lower your debt-to-income ratio;
- find a family member, employer, or friend to cosign on your loan.
How to Improve Your Credit Score
You may also be able to improve your score quickly or in a relatively short time, enough to qualify for a mortgage loan. A low credit score does not always mean poor finances. Instead, it can be due to a series of late payments from simple neglect or transaction errors, like mailing a payment to a wrong address or in the wrong amount. The credit bureaus preparing credit reports and scores treat a 30-day delay as a late payment. Late auto-loan, school-loan, or credit-card payments can lower a credit score by 100 points or more.
Remember, merely getting a mortgage loan isn’t your core goal. Getting the best mortgage loan available to you should be your goal. Take these steps to improve your score, whether you already qualify for a loan or not, to ensure that you get the best loan available to you:
- get your credit report free online to see if your credit score needs improvement because a score above 700 may already qualify you for the best available loan;
- read the report for errors or false-negative information lowering your score, challenging errors, and false reports with the credit bureaus so that they correct your report and raise your score;
- make any overdue payments and otherwise bring any delinquent accounts current so that your report reflects your consistency in meeting credit obligations;
- make all payments timely, even if you can only pay minimum amounts because late payments generally reduce your score;
- pay down and pay off any debts that you can so that your improved debt-to-income ratio improves your credit score;
- when paying off debts, leave the paid-off credit account open so that your credit utilization (how much of your available credit you are using) remains low;
- do not apply for new credit because frequent checks of your credit report and score from potential creditors lower your credit score;
- be patient because the passage of time can alone improve your credit score as poor prior history ages.
Welcome to Philly Home Ownership
Individuals and families often succeed in their lifetime finances when they make the right financial decisions about purchasing a home. Buy wisely, and you may well lead both a happy and financially sound life. Buying a home wisely, though, generally means making smart choices about mortgage loans. Money and mathematics may not come naturally to you. But even if not, spending some time understanding loan options and their financial consequences can make an enormous difference in your life.
Maxwell Realty can assist you in navigating the entire home-buying process. For more than thirty years, Maxwell Realty’s Nancy Alperin and her team have helped people in Philadelphia make their home-buying dreams a reality. Call or email us today to get started.