A good credit score can help you acquire a more affordable home loan. But how good does your credit have to be to get approval from a lender? Read on to find out why credit scores are important to lenders and learn what scores that will get you the best deal on a loan.
Why Lenders Care About Credit Scores
Your credit score is an important figure that gives insight into your credit profile. There are different credit models with slightly different ways of tallying scores. That said, each is based on specific factors that look at your how you have used — and not used — your credit cards, loans, and other credit accounts.
These models also assess your debt-to-credit ratio to determine the likelihood of you having trouble paying back a new loan. For example, if you have already used up much of your credit and are saddled with existing debt; you will be much less equipped to keep up payments on a new loan if you were to lose your job or suffer some other unexpected problem. On the other hand, if you don't have a lot of debt and do have a lot of available credit, you could leverage this to pay your bills while you're dealing with a financial issue or looking for new work.
Because lenders view people with lower credit scores as higher risk, they will usually either deny mortgage loans or apply larger interest rates to help ensure that they get a return on their investment. In short: if you have a lower credit score, you will have more trouble getting a mortgage loan; and if you do get one, you will generally have to pay more in the long run.
What Credit Score Do I Need to Get a Mortgage Loan?
Most lenders will have a standard baseline credit score they use to determine whether to deny or approve a mortgage application. In most cases, any credit score over 700 is good enough to get you a loan agreement with a lower interest rate.
If your score is in the 600s, however, you may start running into problems. While most lenders will approve a score above 660, certain lenders will deny loans for applicants with scores below this mark. That said, some lenders will provide mortgage loans for applicants with scores as low as 620. Bear in mind you will generally have a higher interest rate if you have a lower credit score.
It's also important to understand that these standards only apply to fixed-rate mortgages. Other kinds of mortgages, such as VA or FHA, are generally easier to get for applicants with credit scores that are closer to 500.
Can I Get a Mortgage Loan with Bad Credit?
If your score is in the 500s, you are a candidate for what the real estate industry calls a subprime loan. Not only do these come with additional fees; they also have higher interest rates than loans offered to prime borrowers. For instance, with a lower score, you would likely pay around a 0.375% higher rate of interest on a 3-year mortgage compared to someone with a score above 700. With a 3.875% primary mortgage rate, this would leave you paying about $83 more each month and just under $30,000 more over the entire life of the 30-year loan. If you can't come up with a 20% down payment, the lender will also demand that you pay a PMI (private mortgage insurance) premium that can add substantial annual costs.
As you can see, while you can get a mortgage loan with bad credit, it often makes more sense to wait until you are able to improve your credit score. It’s also a good idea to consult an attorney before you apply for a home loan if you believe your credit score is inaccurate due to a disputed debt.
Are There Any Other Options?
If you believe your credit score will make it hard for you to acquire a conventional mortgage at an affordable rate, consider looking into a Federal Housing Administration (FHA) home loan. FHA loans have more forgiving underwriting standards for applicants with low credit scores, smaller down payments or both.
To get an FHA loan, you must have a minimum FICO credit score of 500. You will also need a 3.5% down payment if your score is at least 580. If your score is under 580, you can still get an FHA loan, but you will need to provide a down payment of at least 10%.