Your credit score plays a significant role in securing that dream house you’ve always wanted. When you borrow money from a credit card or lender, they report payments, including late fees, to the major credit agencies. Overdue payments sent to collection agencies are often on your credit report. It’s simply a credit report for lenders, telling them how one handles money when it’s borrowed. If you pay your bills on time and use your credit wisely, your score will be higher. The lenders will also find you favorable to them, approve your loans, and give you better terms.
On the other hand, if you score low, the lenders might not want anything to do with you. It presents a danger to them, and they may decline your loan or give you harsher terms. This article will look at how credit score affects mortgages and how your good scores may save you money.
The Role of Credit Scores in the Mortgage Process
Applying for a mortgage requires a loan to buy a house. Naturally, lenders want to know you can pay it back, and that’s why your credit history is checked. This rating or scale informs the bank how well you have handled money in the past in terms of paying bills on time and managing debts, though it is not the only factor considered. The Fair Isaac Corporation (FICO) score is used to make about 90% of all mortgage application decisions in the US.
A high credit score indicates a reliable borrower, a responsible person who repays their debts. Therefore, a good credit score benefits you as it implies a greater chance for your loan to be approved.
A low credit score could raise a red flag for loan providers. It could imply you've missed a monthly payment or have considerable debt. Obviously, this leaves them wondering if you can handle a home loan. A low credit score may make it more challenging to get approved, or you might get provided a loan with less attractive terms, like an increased interest rate.
Credit Score Ranges and Mortgage Eligibility
Why Credit Score Matters
As mentioned earlier, credit scores are like report cards for your borrowing habits. They reflect how responsibly you have handled credit in the past. A good credit score indicates that you have a history of managing your debts well.
Let’s say you make timely payments and do not overextend credit limits. This makes you less risky to lenders and can lead to better loan terms like lower rates. You can also receive more favorable repayment conditions. Essentially, higher scores can open doors to better financial opportunities.
Fair Credit Scores (580-669)
You can still qualify for a loan if your credit score falls in this range. But the mortgage rate you receive might not be the most favorable. This means lenders might see you as a slightly higher risk and believe you may not make your monthly mortgage payment on time.
Because of this, you might have a higher interest rate, leading to more expensive monthly payments. However, securing a mortgage with a fair credit score can be a good starting point for building better credit in the future.
The average Native American borrower has a 612 score, while Black borrowers have a score around 627. Hispanic borrowers also fall in this range at around 667. National averages sit around 709, showing how far behind borrowers of color are.
If you fall into this range, an FHA, VA, or USDA loan may be a good option for you, as they generally have lower requirements. You can also provide a smaller down payment with an FHA mortgage if your score is at or above 580, while VA and USDA borrowers do not have to pay anything upfront. Our team at Pride Lending can assist you in accessing these programs, as well as finding assistance programs that will allow you to put more down and access better rates.
Good Credit Scores (670-739)
With a credit score in the “good” range, you have a better-than-average chance of obtaining financing with reasonable terms. This score shows lenders that you are a responsible borrower and don’t make late payments.
It can lead to more favorable interest rates and terms compared to someone with a fair credit score. While it's not the highest category, having a good credit score shows you manage your credit well. It puts you in a strong position when applying for loans.
Very Good Scores (740-799)
If your credit score is in this range, you will likely receive cheaper mortgage interest rates. Lenders view borrowers with very good credit scores as safer bets. This means they are less likely to default on their loans.
This perception of lower risk allows lenders to offer more competitive interest rates. Better terms can save you a significant amount of money over the life of your mortgage.
Excellent Scores (800 and above)
Having a credit score of 800 or higher places you in the top tier of creditworthiness. With an excellent credit score, you’re likely to qualify for the best mortgage terms. The lowest interest rates available are also likely.
This helps companies perceive you as a highly reliable borrower. This means you have demonstrated a strong history of managing your credit responsibly. This top-tier status can lead to substantial savings and more advantageous conditions.
Minimum Credit Score Requirements
A credit score can influence your chances of securing a mortgage loan. The minimum credit score needed varies depending on the type of loan. For instance, conventional loans typically require a minimum score of at least 620. Jumbo loans don't specify a credit score due to their unique nature, though you should expect to have a good or excellent score.
Lower credit scores – those below 620 – might be seen as risky by lenders. This could lead to less favorable loan terms. However, it's important to note that your credit score only confirms your eligibility. It doesn't guarantee approval.
Note that your other financial details must meet the lender's requirements. These details can include your income level, employment history, debt-to-income ratio (DTI), etc. Even if your credit score is low, you might still qualify.
Government-Backed Loans
Government-backed loans have the government's guarantee; if you can't repay the loan, the government will take responsibility for it. The main types of these loans are USDA, FHA, and VA loans.
USDA Loans are backed by the United States Department of Agriculture and are designed to help home buyers with low-to-moderate incomes in rural areas. The typical minimum credit score for these loans is 620.
FHA Loans are backed by the Federal Housing Administration. They're popular among first-time homebuyers, require a low down payment, and have flexible credit score requirements. While Federal Housing Administration loans can allow credit scores as low as 500, most lenders prefer scores of at least 580.
These loans are a crucial way to reduce racial disparities. 30.63% of FHA products last year were provided to borrowers of color. This is significantly higher than the private lender products provided to borrowers of color.
The Department of Veterans Affairs backs VA Loans, which are available for active service members, veterans, and some surviving spouses. There's no set minimum credit score for VA loans, but most lenders look for a score of at least 620.
A VA mortgage is an excellent way for veterans of color to achieve homeownership; in fact, it makes a huge difference in whether Black individuals are able to purchase a home. The homeownership gap between white and Black veterans was 18.5%, compared to almost 30% for Black and white civilians.
Conventional Loans
These are mortgages that the government doesn't insure. They're a popular choice among home buyers. Private lenders give these loans, and there are two main types of them: fixed-rate and adjustable-rate.
The most popular standard loan is a conforming loan. This type of loan follows the guidelines set by the Federal Housing Finance Agency (FHFA) and meets additional standards set by Fannie Mae or Freddie Mac. Those that go beyond FHFA loan limits are known as a nonconforming loan. Jumbo loans are a common type of nonconforming product.
These products are quite popular with LGBTQ+ borrowers: in fact, 83% of same-sex couples bought their homes with a fixed-rate conventional loan.
To qualify for this product, you typically need a credit score of 620 or higher. This credit score requirement is stricter than those for government-backed loans. However, the exact credit score needed can vary. Factors include the loan amount, debt-to-income ratio, and others.
How Credit Score Affects Loan Options
Higher Credit Scores
Companies see you as a less risky borrower if you have a higher credit score. This means you're more likely to repay your loan on time. A good score in the context of a mortgage could mean you can borrow a larger amount at a lower interest rate.
Lower Credit Scores
Conversely, a lower credit score can make things a bit more challenging. A lender might think you're a riskier borrower. A lower score might also mean you're offered a smaller loan amount with a higher interest rate.
So, maintaining a healthy credit score is essential for better loan opportunities. Whether you want financing for a home or a car, a higher credit score can open the door to more possibilities.
Sadly, many of our clients face significant issues in regard to their scores due to discrimination. LGBTQ+ individuals are more likely to have lower credit scores, and Black borrowers have scores that are, on average, 100 points lower than their white peers.
However, Pride Lending is here to assist everyone, no matter their identity, in accessing programs that meet their needs. We’ll take a look at your financial situation and match you to banks, credit unions, and other institutions that are willing to lend to you, whether that is with a conventional loan or government-backed product.
Credit Scores and Interest Rates
Here's where the two connect:
Higher Scores = Lower Interest Rates: A mortgage lender will view you as a low risk if you have a good score. They think you are more likely to pay back your loan on time, so they offer you a better deal. This means you pay less to borrow money.
Lower Credit Scores = Higher Interest Rates: Lenders see you as a higher risk if your credit score is low. They are not as confident that you will repay your loan on time, so they charge you a higher interest rate to offset risk. This means you pay more to borrow money. You may also have to provide a larger down payment.
This applies to all kinds of loans, including credit cards, auto loans, and mortgages. For example, the bank will look at your credit score when you apply for a mortgage. If it is high, you will likely be offered a product with a lower interest rate. But if it is low, your mortgage interest rate could be higher.
Estimating Potential Interest Savings
Consider two individuals: Person A has a high score, and Person B has a lower one. Person A, with the higher credit score, is likely to secure a mortgage with a lower interest rate. This means their monthly payments will be lower, and they'll pay less interest over the life of the loan.
On the other hand, Person B, with a lower score, may face a higher interest rate. This leads to higher monthly payments, which, over time, will result in higher interest payments.
Online calculators and tools can help illustrate these differences. These tools can be valuable for anyone looking to understand the financial impact of their credit score.
By inputting various credit scores, users can compare different scenarios. For example, they can see how improving their credit score from Person B's to Person A's could lead to substantial interest savings.
Credit Scores and Other Loan Terms
Your FICO scores play a pivotal role in determining your mortgage's terms.
Down Payment Requirements
The down payment amount you're required to make can be influenced by your credit score. Those with lower credit scores may need to make higher down payments.
This is because lower credit scores can impact the loan-to-value ratio (LTV), which is a key factor in mortgage approvals. In essence, a higher down payment could offset the risk posed by lower credit scores.
While it is possible to put between 3% and 5% down on a home, offering at least 20% will eliminate private mortgage insurance and help you access the best rates. We understand that this can be a significant challenge, which is why Pride Lending will help you access local, state, and national assistance programs that can provide you with grants or loans for this initial expense.
Private Mortgage Insurance (PMI)
If your score is lower, you may be required to pay for Private Mortgage Insurance (PMI). This type of insurance protects the lender if you fail to pay your mortgage. However, a higher credit score could save you money. It might reduce or even eliminate the need for PMI.
Loan Fees and Closing Costs
Lastly, your score can affect loan rates. Borrowers with lower credit scores may face higher rates. However, a stronger credit profile can give you more negotiating power, which could lead to lower costs.
Other Factors Affecting Mortgages
While credit score is a key factor in securing financing, companies consider a variety of other factors to determine your eligibility.
Type of Credit Score Mortgage Lenders Use
Lenders typically use a type of credit score known as the Fair Isaac Corporation (FICO) score. This score is provided by three credit bureaus – Experian, Equifax, and TransUnion.
These credit reporting agencies compile data about your overall credit history. The higher your score, the more likely you will be approved. Lenders use the FICO score to gauge your creditworthiness. They assess the risk involved in lending to you.
Income and Employment History
Your income and employment history are crucial in demonstrating your ability to repay the loan. Lenders want to see stable income and a steady job history. This reassures them you have a reliable income stream to make your mortgage payments.
For instance, it shows stability and reliability if you've been employed at the same company for several years. Conversely, frequent job changes or gaps in employment might raise concerns for lenders. They want to ensure you can consistently meet your monthly mortgage obligations.
Debt-to-Income Ratio (DTI)
Your debt-to-income ratio (DTI) compares monthly debt payments to gross monthly income. It helps lenders assess your ability to manage debts. If your DTI is low, it means that your income and debt are well-proportioned.
This makes you a more attractive borrower. For example, if a large portion of your income is already committed to existing debts. Lenders may worry about your ability to take on additional mortgage payments. Keeping your DTI low can improve your chances of mortgage approval.
Assets and Savings
Companies also consider your assets and savings when evaluating your mortgage application. Boosting your odds is possible with a heftier down payment. This can influence the approval of a mortgage.
Additionally, having financial reserves can show lenders you're capable of handling unexpected expenses or changes in income. For example, savings in the form of a rainy-day fund or investments can reassure lenders. They see it as a sign that you have a safety net in case of financial difficulties, making you a less risky borrower.
Loan Type and Property Type
The type of financing and property you're considering can affect your mortgage eligibility. Conventional loans, FHA loans, or VA loans have different requirements. For instance, VA loans are available to veterans. They may offer benefits like no down payment, but they have specific eligibility criteria.
Similarly, the type of property you're buying – a primary residence, second home, or investment property – can also impact the lender's decision. Primary residences usually have favorable terms. However, second homes or investment properties might have stricter requirements and higher rates.
Tips for Improving Your Credit Score for a Mortgage
Approximately 15% of Black and Hispanic borrowers are “credit invisible,” meaning that they do not have any credit history. This can make it very challenging to access funding for a home, as this is one of the most important metrics that companies use when deciding whether you’re eligible. It is critical not only to start building up your score by opening accounts and paying bills, but also to watch for chances to improve your score.
Improving your credit score is a long-term process that requires patience and diligence. Here are just a few points to help you build a better credit profile for a mortgage.
Check Your Credit Reports for Errors
Only 84% of LGBTQ+ borrowers report knowing their score, which is an essential element of accessing home loans.
However, just knowing the number is not enough: you need to ensure that everything included on your reports is accurate and that you’re not missing any details that may damage your chances of being approved.
Regularly checking your reports can help you spot errors dragging down your score. Obtain reports from major credit reporting agencies like Equifax, Experian, and TransUnion. If you find any inaccuracies, dispute them immediately with your credit reporting agency. Ensuring your credit report is accurate is crucial for securing a mortgage.
Pay Bills on Time
Consistently paying your bills on time is one of the most effective ways to build a positive payment history. Failing to pay on time could considerably damage your credit score. Set up reminders or automatic payments to avoid missing due dates. A strong payment history is essential for a good or excellent score. This will make it easier to qualify.
Several bills can appear on your credit report. Credit card companies often report monthly to major credit reporting agencies, including when you are late on payments. Gym memberships, utility bills, and medical bills will appear on your credit report if sent to a collections agency. Work with collection agencies to develop a payment plan and make timely payments to show you are financially responsible.
Reduce Credit Card Debt
Reducing your card balances will lower your credit utilization ratio, a critical factor in your score. Aim to keep your credit utilization below 30% of total available credit. Paying down high credit card balances improves your score. It demonstrates responsible debt management, which is favorable when getting the best mortgage rates.
Limit New Credit Applications
Every time you apply for new credit, it can negatively impact your credit score. Avoid opening multiple new credit accounts in a short period, especially when you're planning to apply for home financing. Each new inquiry can lower your score and signal potential financial instability to a mortgage professional.
Consider Credit Counseling or Debt Management
If you have a low score or are struggling with debt, seeking credit counseling can be beneficial. Professional credit counselors can help you develop a plan to manage your debts, which can improve your financial health.
Enrolling in a debt management program can also provide structured support to pay off your debts and can improve your credit over time, making it easier to achieve a higher score.
Following these tips and maintaining a disciplined approach to finances can gradually improve your credit score, enhancing your chances of obtaining a mortgage.
Summary
Your score significantly impacts your ability to secure a mortgage and the terms you receive. Higher scores indicate reliability, leading to better terms. Lower scores suggest risk, resulting in higher rates and stricter terms.
Ultimately, managing your credit responsibly can enhance your financial profile and increase your chances of obtaining a favorable mortgage. Improve your credit score for better mortgage opportunities.
Pride Lending is here to help you explore your options for loans, including advice on how to boost your chances of success. We are the first mortgage broker that specializes in options for LGBTQ+ borrowers; our team is composed of allies and members of marginalized communities, including LGBTQ+ and BIPOC individuals.
Our goal is to help everyone, no matter their background or identity, achieve their financial goals of homeownership. We strive to provide excellent service to all our clients, advocating for them and matching them to resources that meet their needs.
If you are ready to get started with the pre-approval process or need more information about your options, contact us today via email at Andrew@pridelending.com or phone at 725-231-0192.
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