What Are Credit Scores and Why Are They Important for Buying a Home?

What Are Credit Scores and Why Are They Important for Buying a Home?

A credit score is a numerical value assigned to individuals based on their credit history. They can range from 300 (very poor) to 850 (excellent) and help financial product vendors determine whether someone is suitable for a particular loan. 

Your credit score could affect whether or not you qualify for a mortgage, so you must optimize your rating before starting the homebuying process. To help maximize your chances of securing your dream home, therefore, we’ve put together a quick guide to credit scores below.

What factors can affect a credit score?

Several factors affect the calculation of your credit score. By order of importance from highest to lowest, these include:

  1. Payment history: If you pay your credit card bills on time, your score will be higher.
  2. Duration of credit history: Your score will be higher the longer you’ve dealt with credit.
  3. Credit utilization rate: This figure represents the total amount of credit you’re using in proportion to your credit limit.
  4. New credit: In other words, how often you open new accounts and apply for credit. 
  5. Credit mix: You can attain a more robust credit mix if you take out a variety of credit accounts and installment loans. 

Essentially, the more experienced you are with taking out and paying back loans on time, the closer your credit score will be to 850. If, however, you have a history of late payments or underpayments, your score may edge closer to 300. 

How do credit scores affect mortgage lending?

The higher your credit score, the more likely lenders are to offer you a mortgage. However, your credit score does not need to be perfect if you want to qualify for a loan. Only 1.6% of Americans have a score of 850, and a score of 760 will still give you access to the vast majority of financial products.

Ultimately, the score you need to purchase a home will depend on the type of mortgage loan you need, as well as decisions made by your lender. For some people, it is possible to obtain a loan with a bad credit score, albeit with relatively restrictive terms. 

Your credit score will heavily influence your mortgage loan’s payment terms and interest rate, as lenders use risk-based pricing models to come up with fair terms. If your credit score is bad to fair, therefore, it may be worth waiting and improving your score before you start approaching lenders. 

What credit scores do buyers require for particular kinds of loans?

There are several different mortgage types open to buyers, each of which has unique credit score requirements. Here are some general guidelines for what to expect from different types of loan:

  • Conventional loans: These loans are not insured by government agencies and usually require a credit score of at least 620.
  • Federal Housing Administration (FHA) loans: These loans are insured by the FHA and require a score of at least 500 for 10% down payments or 580 for 3.5% down payments.
  • Jumbo loans: These loans are higher than conventional loans, meaning they’re riskier for lenders. As such, most jumbo loans require a score of at least 700.
  • VA loans: The US Department of Veteran Affairs insures these loans, which are ringfenced for certain members of the military community and their family members. VA loans don’t officially require a minimum credit score, but most lenders ask for a score of at least 620.
  • US Department of Agriculture (USDA) loans: USDA loans are targeted at low- and mid-income buyers looking to purchase property in rural communicates. The minimum credit score for a USDA loan is 580. 

As you can see, improving your credit score will help you secure some of the best loans and enjoy a more stable financial future.

How to prepare your credit score for mortgage applications

Preparing to apply for mortgages? Here are a few tips for boosting your credit score:

  • Pay off debts: Relieving your debt burden will improve your debt-to-income ratio, improve your credit score, and boost your trustworthiness in the eyes of lenders. 
  • Avoid new credit applications: Lenders run inquiries on credit reports when an applicant applies for new credit. Incurring multiple inquiries in a short space of time could negatively impact your credit score.  
  • Be patient: It can sometimes take time for poor credit scores to recover. If you’ve experienced bankruptcy or serious debt problems in the past few years, you may need to wait to buy a home.   

Ask your real estate agent about credit scores today!

Confused about credit scores and loan terms? Ask a friendly real estate agent about your options.