If you are looking to buy a home, a major consideration is your credit score. A poor credit score is certain to make applying for a home loan a lot more difficult. There is no standard credit requirement. It can vary with the different mortgage options. Let’s take a look at the preferred credit score requirements for the different loans.
What credit score is needed?
After getting in touch with a mortgage lender, one of the first things they will do to see if you match the qualifying criteria for a home loan is to check your FICO score. There are several other credit bureaus, but this is the one mostly used by the lenders. Many factors are considered by the lenders, but the credit score will give a quick indication of a borrower’s credit worthiness.
The type of home loan will determine the minimum credit score required. Before the major crash in 2007-2008, the rules for applying for a home loan were more relaxed with a greater opportunity to apply for a subprime loan. Today, the mortgage industry has seen its laws tighten with stricter qualifying criteria. This has made it more difficult for those with a low credit score to apply for a loan.
However, for first-time buyers, there are still plenty of opportunities to apply for a mortgage if you don’t have the perfect credit score. For instance, the FHA loan is likely to appeal to the future borrowers with a poor credit rating.
They are often referred to as a type of bad credit loan and said to have the lowest qualifying criteria of any mortgage on the market. The lowest credit score accepted for the FHA loan is 500, but this will be subject to a 10 percent down payment.
However, the ability to get accepted at the 500-579 credit score range isn’t the most straightforward. Most lenders will prefer applicants to have a FICO score of 580 or more. At this range, the down payment requirement is lowered to 3.5 percent.
If you don’t have the most attractive credit score to home lenders, it may be worth the extra effort to improve the personal finances before making a home loan application.
What are the typical FICO scores?
The typical minimum acceptable credit score will differ by mortgage type:
FHA Loan – a credit score of 500-579 is an option, but very difficult to get approved. The standard minimum credit score is 580 or more.
VA Loan – a credit of 580+ is required for this type of loan – although most lenders prefer 620 or more.
203K Loan – a combined home / repair loan like the FHA 203K relies on a credit score of 620 or more.
Conventional Loan – the standard rule is a credit score of 620 or more.
USDA Loan – the USDA loan has a qualifying credit score of 640 or more.
How to check your credit score?
The credit score is easily checked by getting in touch with one of the major credit bureaus (TransUnion, Equifax and Experian). All the bureaus will provide a free copy of the credit scores and reports provide an application is done once every 12 months.
Also, there are a few useful apps like Credit Karma and Credit Sesame that can issue an alert in the event of something changing on your credit profile.
What else do home lenders consider?
Mortgage lenders are now very effective at determining which would-be buyers are likely to be in a good position to complete the monthly payments. Beyond looking at the credit score, there are a few other things to consider. It is typically helpful if you are able to show you recovered from a past financial hardship that related to an economic event.
Also, the total outstanding debt on your account will be considered. For the borrower’s with minimal or no debt, this can be used as a compensating factor to help with the approval. Any borrowers with a low credit score will significantly increase the likelihood of getting approved when there are compensating factors that lower the lender’s risk.
Additionally, it will help to have a credit history that shows a reliable payment history with no late payments in the last year. Solid employment history and low debt-to-income ratio are also factors.
Bad credit compensating factors include:
Low debt-to-income ratio
Above average income
Long-term employment history with the same company
Decent size savings account
What is the range of credit scores?
The credit bureaus (TransUnion, Equifax and Experian) will grade each individual person with a score between 350 and 850. There are slight variations on the reports, so the three reporting agencies will likely have different scores. Typically, a score at 620 or below is seen as poor, while a score of 700 or more is deemed to be good by the majority of lenders.
Bad credit score is a rating of 500 to 579
Poor credit score is 580 to 619
Fair credit score is 620 to 679
Average credit score is 680 to 739
Great credit score is 740 or more
How does the credit score impact the interest rate?
While it may be possible to get approved with a low credit score (579 or below) the terms and interest rate offered by the mortgage company won’t be the most favorable.
For instance, a score at 579 or below can mean the interest rate is at least 2 percent higher than those individuals with the most favorable credit history. Also, for the buyers with a credit score between 580 and 679, the interest rates will increase by 1 to .5 percent.
The preferred range to get the most favored interest rates is for the buyers at 680 to 739. On average, the majority of prospective home buyers will have a credit score in this range. In addition, the buyers with a credit score of 740 or more can enjoy the most attractive terms offered by the mortgage companies.
In many situations, it will benefit to take positive steps to improve the poor credit score before applying for a home loan because it can make a significant difference over the full term of the loan period.