Mortgages are often the most significant debts you can take on in your life. And because it deals with an incredible amount of money, lenders will need to scrutinize your financial background even more than usual before you are granted a loan.
The first sign that tells you whether you have a chance to qualify for a mortgage is the status of your credit score. You can get three different credit scores from Experian, Equifax, and TransUnion, but the mortgage lender will only take note of the median value.
Your credit score affects your home loan in two ways. First, if your credit score meets a loan’s minimum credit score requirements, that’s already your ticket inside. Once the finer details are ironed out, though, your credit score can play another role in determining how much you need to prepare for a down payment or how much your mortgage is going to cost you in fees.
Today, let’s find out what mortgages you can become eligible for according to specific credit score ranges.
Table of Contents
First, though, we need to learn the credit score basics. These FICO Scores in your credit reports become more than just numbers once you understand how the three major credit bureaus can come up with them.
How Your Credit Score Is Computed
Payment History (35%)
The most significant chunk of your FICO Score will measure how often you have been able to pay your bills on time without leaving any balances. Late payments are absolute no-nos if you want to get a decent credit score.
Since we’re only human, though, we’re still bound to commit mistakes from time to time. If you’ve made a late payment in the past, how recent it is will determine how it will affect your score. The longer it has been, the better.
Needless to say, if you have entirely been negligent on any of your past loans and debt, this part of your FICO Score is going to take a beating. Remember, this negative information can stay on your record for up to seven years. No matter if you have long improved your borrowing behavior.
Amount Owed (30%)
Of course, a thousand dollar loan makes a lot of difference to a hundred thousand dollar loan. With this in mind, you want to know how much you owe in total and how much you are paying to different lenders. You also want to ask yourself, how much of your income represents money you put aside to pay your monthly debt?
The key phrases to learn here are credit utilization ratio and debt to income ratio.
Millions of Americans charge their day-to-day expenses on credit cards. If you total your monthly charge across all your cards and all your credit limits, you can determine how much of your whole credit line you use in one billing cycle. To keep yourself in check, make it a rule never to spend more than 30% of all your credit limits. This is your credit utilization ratio.
On the other hand, the debt to income ratio or DTI ratio refers to how much debt you pay for each month compared to the money you bring in. If it relieves you to know, only the minimum payments required are used to compute your DTI. For example, if your credit card statement says that you owe a total of $1000, but you only need to pay a minimum of $100, you only need to take note of the $100 when you get your DTI ratio.
Unlike credit utilization, your DTI does not directly affect your credit score. However, since you’re already computing for your total amounts owed, it would be helpful if you also become aware of your DTI. Aside from your credit score, this is another factor that lets mortgage lenders know whether you qualify for a mortgage.
Length of Credit Relationship (15%)
An excellent way to maintain excellent credit is by keeping your credit cards, no matter if you hardly ever use them for transactions.
It does pay not to burn bridges. It makes a difference if you can show that you already have a long history with credit. So list down all your credit accounts and note down when you opened them. Find out which of your credit cards you’ve had for the longest and make sure you never cancel this account.
New Credit (10%)
Related to your length of relationships, it can significantly affect your credit score if you open a bunch of new accounts within a certain period. Each new credit line adds to the risk lenders will see in you when you apply for a loan. They’ll want to know the purpose of your additional debt and if there has been a similar bump in your income.
Every time you get a new credit card or submit an application for a mortgage, this part of the FICO score decreases. So the best thing to do is to put a lot of months in between each new application, especially if your previous one gets rejected.
Credit Mix (10%)
The variety of your credit accounts also dramatically improves your credit score.
Aside from credit cards, lenders will want to see a healthy mix of other types of loans in your portfolio. This is why once you get a mortgage for the first time, this can positively impact your credit score.
Credit Score Ranges
Some scores are referred to as bad credit. This is because there is a specific rating where good credit begins.
FICO Scores range from 300 to 850, where 300 is the lowest possible FICO Score, and 850 is the highest. You can only generate a FICO Score months after you open your first credit account. If you don’t have a FICO Score, it may simply mean that you have nothing to show in your credit report. And this is true for a lot of Americans. If you actively choose to always pay in cash, it is possible to become credit invisible.
The Good credit score range starts at 670. Credit scores below this number are technically bad credit, but there are nuances. For example, from 300 to 579, your credit score is considered Poor, and from 580 to 669, your credit score is deemed fair.
There is also an Exceptional range of FICO Scores that start at 800. But attaining this level won’t make any further distinction to your mortgage application. As long as you can maintain a good credit score, you already become eligible for many available home loans.
Home Loan Based on Credit Score
When your credit is between 300 to 500
Two government-backed loans do not have credit score requirements. These are VA loans and USDA loans.
VA loans can be pretty exclusive because these are mortgages insured by the Department of Veterans Affairs, i.e., you have to be a veteran to take advantage of this job benefit. And beneficial it truly is.
Aside from no credit score needed to apply, you don’t have to make a down payment to close this type of loan. In addition, you will be given market-competitive interest rates, and you also won’t be charged for mortgage insurance.
On the other hand, USDA loans do not require a specific profession to approve your loan. However, you want to know if your location is considered a rural area by the U.S. Department of Agriculture to apply for a mortgage.
It is necessary to keep in mind that while these government-backed loans don’t ask for a minimum score, mortgage lenders will have their requirements. Ideally, you should be approved for a USDA loan, for instance, regardless of whether you have a 400 credit score or a 550, as long as you satisfy USDA eligibility. Strictly speaking, though, you will be hard-pressed to find a mortgage lender who will be this lax in minimum credit score requirements without having other demands.
When your credit is between 500 to 580
The Federal Housing Administration is another government agency that insures another type of mortgage.
The FHA loan is probably the most common government-backed loan because it doesn’t limit your location or ask for a specific employment background. In addition, you only need to have a minimum credit score of 500 to qualify for a mortgage.
When you have a credit score from 500 to 579, the minimum down payment you need to make is 10 percent. You can also get this down payment from other sources aside from your savings. For example, if your parents are willing to help you buy a house, you can accept gifted funds for a down payment. However, they will need to sign a document to ensure that they waive any right to ask you for repayment in the future. Additionally, you can find out if your state has down payment assistance programs that might provide you with a grant for your FHA loan.
These are all possible because the FHA loan’s primary aim is to help out first-time home buyers.
When your credit is between 580 to 620
If you’re getting an FHA loan and you happen to have a credit score of at least 580, you can choose to pay a low 3.5% down payment on your mortgage.
It is prudent to remember that the lower the down payment you make, the more you eventually owe because your debt is exacerbated by interest.
For FHA loans, there is also an unavoidable mortgage insurance premium you have to pay for over the whole life of the loan.
When your credit is 620 and beyond
Finally, when your credit score is 620 or higher, you can start qualifying for conventional loans. These are your basic mortgages lent by private institutions.
A 620 credit score is not yet even in the Good FICO Score range, but this can already be enough to score you the only type of loan you should aim for.
Like FHA loans, conventional loans have the edge over VA and USDA loans because these are not restrictive for location and profession. It has a further advantage over FHA loans, though, because, with conventional loans, it will be possible for you to steer clear of private mortgage insurance, which is essentially the same as the insurance paid on FHA loans.
You have to make sure that you are okay with borrowing only up to 80% of your home’s purchase price. If a 20% down payment is too expensive at the moment, you can still make a down payment starting at 3 percent. Eventually, once you own more than 20% of your home, the lender will stop including insurance in your monthly charges.
Mortgage lenders use your FICO Score to determine your risk as a borrower. The greater the risk, the lower your FICO Score. This can happen if you miss out on paying your bills, you max out your credit card limits, or you open too many accounts in a short period.
The better your FICO Score is, though, the bigger your reward in the form of a well-deserved mortgage.
The ideal home loan is different for everyone because we all have our individual needs and preferences. However, we can all agree that the cheaper your mortgage, no matter what type or from which lender, the better it is for you.
Do you have what it takes to score savings on your home loan?
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