You hear you need a good credit score to buy a house. Just what is considered good credit? How will you know if you qualify? Before you apply with a lender, read our guide on how to learn about your credit. The more information you have going into the process, the better your chances of approval.
Know the Minimum Credit Score for Your Program
Each loan program has a minimum credit score required. Starting there can help you determine where you stand. Following are the minimum credit scores for most programs:
- Conventional – Fannie Mae won’t accept a credit score lower than 620, but most lenders require scores slightly higher
- FHA – The FHA allows credit scores as low as 580, but will allow scores as low as 500 with a 10% down payment
- VA – The VA requires a credit score of at least 620
- USDA – The USDA requires a credit score of at least 640
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Keep in mind, these minimum credit scores are what each program requires. They are not what the lender requires. At a minimum, the lender must use the published guidelines. However, they can require higher credit scores if they wish. The lender funds the loan, so they have the final say in what type of risk they want to take.
Is a Good Credit Score Necessary?
Assuming you meet the requirements of the program and the lender, you may still want a good credit score. If nothing else, it helps you with negotiating your costs and interest rate. In general, lenders look at lower credit scores as riskier.
A lender must protect themselves against the risk of foreclosure. They do this by charging higher interest rates and/or closing costs. Because the lender is in the business to make money, they make sure they make the money up front. This way if you do default, they still made a little profit on your loan.
If you have a higher credit score, you may be able to negotiate a lower interest rate and/or closing costs. A higher score signifies more financial responsibility. Just how much you’ll save depends on the lender. There isn’t an exact calculation you can use. But, it does give you more bargaining power, especially if you shop around with different lenders.
If you borrow more than 80% of the home’s price, you’ll want a high credit score as well. This helps lower the amount of PMI you must pay. PMI stands for Private Mortgage Insurance. Every conventional loan with an LTV higher than 80% requires it. The insurance company bases your premium on your credit score and LTV. If you have a higher score, you may pay less PMI.
What if You Have a Low Credit Score?
Luckily, if you have a low credit score you may still secure a loan. But, it might be more expensive. The lender might bump up your interest rate. They may also charge you an origination fee. This is a percentage of your loan amount. So on a $100,000 loan, 1 point would be $1,000. Lenders can charge up to 3 points on your loan. That can really add up!
The good news is you can improve your low credit score. Unless you need a mortgage right now, take the time to implement some of our credit improving tips below.
Improving your Credit Score
Luckily, improving your credit score can happen fairly quickly. You must be consistent with your efforts though. First, you must determine why you have a low score. A few reasons may include:
- High utilization rate – If your outstanding balance is more than 30% of your available balance, it can negatively affect your credit score.
- Late payments – If your credit history is laden with late payments, you must bring your accounts current.
- Accounts too new – If you don’t have established credit, it could affect your credit score. The older your accounts the better it is on your score
Here are a few ways you can make your score higher:
- Pay down large balances. Start with the highest balance and work your way down. Credit bureaus figure your utilization rate based on your total available credit. They total all of your credit card available balances. They also total your outstanding balance. The ratio between the two is your utilization rate. Paying down large balances can help lower it.
- Make your payments on time. You’ll need to establish a proper history of making payments on time. This doesn’t mean just a month or two. You’ll need to keep up the habit for the next 6 to 12 months to see a difference.
- Don’t close old accounts – Even if you have accounts you no longer use, keep them open. If nothing else, the age of the account can help improve your credit score.
In general, watch how many new accounts you open as well. Each inquiry knocks a few points off your credit score. If you have too many it can negatively affect your score.
Before you apply for a mortgage, make sure you know what your credit looks like. Request your free credit reports from each credit bureau. This won’t show your credit score, but you’ll be able to see the history. You can fix any issues, such as those discussed above. Without any issues reporting, you have a better chance of having a higher credit score.
Many services offer free access to your credit score as well. Check with your bank or credit card companies to see if they offer it. This is a great way to stay on top of your credit without paying for credit monitoring. The services alert you when your score changes. This can help you make any necessary adjustments to make sure you have a good credit score for your mortgage.
The bottom line is you need a good credit score to get a loan. You might get away with a lower score, but it will cost you in the end. If you would rather save money, do what you can to improve your score. This way you never have to pay the higher rates or closing costs. These are investments you never make back. Invest wisely and you can make the most of your homeownership.