The Federal Housing Administration (FHA) loan is often referred to as a first-time homebuyers' loan,…
Whether you are already planning to buy a house in the next year or in five, it’s never too early to start working on your credit score. After all, maintaining a good rating can also prepare you for emergencies, in case you find yourself in need of a loan, or even when you need to apply for a job.
Knowing your credit score also gives you direction. Frequently maxing out your credit cards can take points out of your rating, and being conscious of where you stand on the scale can help you be more in control of your spending habits. You don’t want to be caught off guard by a low credit score right when you need to qualify for a mortgage.
However, people can really change a lot even in a few years’ time. House prices also go up and down as frequently as the weather permits. How do you prepare for a house purchase you haven’t decided upon?
Today, we’ll clue you in on how to get your credit score in that sweet spot where you can get approved for almost any kind of home loan that will suit your style. We’ll also talk about the possible options you can choose from according to your particular needs and circumstances. Trust us, investing in this knowledge today can save you tens of thousands of dollars tomorrow!
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Why Credit Scores Are Important
When you think about it, money bills are just fancy paper with numbers printed on them. But if you give some to a person, you can get something in exchange that is worth so much more than the paper those digits are printed on.
Our whole financial system is built on trust. People entrust their savings to banks, and in turn, banks need to trust people by giving out loans. Being human, however, we are bound to make all kinds of mistakes and find things out of our control. To protect the system, banks need to make sure that they are lending money only to the right people, and this is why credit scores and credit reports are essential to maintain order in the economy.
Subprime Mortgage Crisis
There are several lessons to be learned from the subprime mortgage crisis. It has been over ten years but it is still fresh in the minds of a lot of people. This was a global crash that today serves to drive home the point of how important credit scores are to the whole financial institution.
In a nutshell, thousands of subprime borrowers, or those with less than stellar credit scores, defaulted on their mortgages after the housing bubble popped, starting a domino effect that reverberated around the globe.
It is often taken for granted how our credit score can be used as a barometer for financial readiness. Sure, these values are more for the purposes of letting lenders know if you are reliable enough to be lent a certain amount of money. But as a borrower, you can also use this as a way of knowing how you have been keeping up with your finances. You must not simply leave it up to a lender to decide if you are ready to borrow money. Keep in mind that over a decade ago, thousands of people were driven out of their homes because of this very expectation, when they trusted a system that unfortunately failed to protect them.
The Minimum Credit Score to Buy a House
In order to know that perfect credit score level you can maintain to ensure faster approval once you decide to get a mortgage, you need to know the minimum credit score needed in order to qualify for a loan type.
Here are some of the most common home loans you will encounter in the market.
Let’s begin with a type of loan that actually does not specify any credit score requirements.
That’s right, with a USDA loan, or a mortgage guaranteed by the U.S. Department of Agriculture, you don’t really have to worry about your credit score, as long as you don’t mind buying a house in a rural area. With a USDA loan, you don’t even have to make a down payment as long as the property you are purchasing is in an eligible location.
They say that with a 640 credit score, you might experience a smoother application. Borrowers with lower credit scores, on the other hand, will need to prepare for a manual underwriting process.
One government-backed loan type that’s always been popular through the years is the FHA loan. This is a mortgage that’s insured by the Federal Housing Administration.
It’s a good fallback to rely on because you only need a minimum credit score of 500 in order to qualify, and a FICO Score of 580 can even help you borrow up to 96.5% of your house purchase price. The FHA also allows this 3.5% down payment to be taken from either a cash gift or a grant.
If you’re a little overqualified for an FHA loan, you might want to set your sights on a conventional loan. However, this will be more to your advantage if you can set aside money for a 20% down payment, although you may be allowed to pay as low as 3 percent. This is because when you pay less than 20 percent, you will be required to pay for private mortgage insurance which really serves to protect the lender in the event that you stop making payments.
The minimum credit score needed in order to get approved for a conventional mortgage is set at 620. Take note, however, that this can vary lender to lender. Since conventional loans are the complete opposite of government-backed mortgages, lenders will want to safeguard their investors by asking for higher FICO Scores.
Finally, if you are a service member or qualified spouse of a veteran, you’d do well to apply for a VA loan, or a mortgage insured by the U.S. Department of Veterans Affairs.
Of late, these loans have been in high demand despite the pandemic, due to the Blue Water Navy Vietnam Veterans Act of 2019 which took effect last year. And this is not surprising considering the highly competitive interest rates they can offer as well as the zero down payment required in order to secure your loan.
Aside from military service, however, you also need to have a credit score of at least 640 in order to qualify.
The Credit Score to Maintain
Now that we know the credit score needed in order to qualify for each of the most popular loans, we can finally get to the bottom of our main question: “What should my credit score be if I want to qualify for a mortgage?”
There are two ways to answer this question. The biggest determinant will be if you are a service member or spouse of someone who is, because if you are, there is no doubt that a VA loan will be the best deal to take. For the greater majority of us, however, the best credit score to maintain or at least improve from is 620.
With a 620 credit score, applying for a mortgage as a first-time home buyer can become a piece of cake, especially if you are not asking for an astronomical loan amount.
Tips for Faster Approval
If you’re still sitting there without any idea what your credit score is, what are you waiting for? Did you know that you are actually entitled to a free credit report from each of the three major credit bureaus? It’s true.
At this point in time, there’s not a lot of excuses you can really make for why you are not working to improve your credit score. When you stop to consider it, you are actually taking a lot of risk if you have no clue about your credit score. Loans are one of the first things people turn to during emergencies and it does take time to increase your credit.
Here are a few surefire ways you can try in order to kiss that bad credit goodbye.
- Pay your bills on time. Payment history composes a big chunk of your FICO Score. It’s not enough to pay your bills. If you’re not paying them on time, you might as well not be paying them at all, because the dates when you pay them really matter in your credit report. It’s just a good habit to keep as well, because you get to avoid paying interest.
- Check your credit report as often as you can. It’s more necessary especially if you are working to attain good credit. You might not be aware of this but errors in credit reports are actually more common than you think. They happen quite often enough that the Federal Trade Commission actually has a page dedicated to sorting out such a mess. Pay attention to the tiny details in your credit history, because you never know when a single line might be the only thing standing in your way of getting a better interest rate on your loan.
- Keep your credit utilization ratio low. If you have a credit card or two, this is much easier to track. Your credit utilization ratio represents how much money you owe against how much money you are really allowed to borrow. The magic percentage to maintain is 30% although you would do well to keep it well below this number.
Even today in 2020, it’s completely doable to get a mortgage loan with a credit score of 500. However, you do increase your chances of getting better mortgage rates with a credit score of 600 or higher.
Whatever credit score you currently have, keep in mind that there’s no such thing as bad credit for someone who is absolutely determined to buy a house. The question is: are you up to the challenge?