If you've been finding it hard to choose a mortgage, you're not alone. Home loans…
No one likes to be defined by numbers. However, there are unavoidable aspects in our lives when we have to rely on such figures to get closer to our goals. The good news is, with such measurements as credit scores, some numbers are within our control. After all, our credit score is just a reflection of the sum of our financial decisions.
If you are thinking, “That doesn’t seem completely true. Surely, some factors affect our credit scores that are just out of our spheres of influence.” Today, let’s break down that misconception so we can help you get a mortgage by improving the credit rating you have at the moment.
Just hear us out! We promise that it will be worth your time.
What’s in a Credit Score?
This might surprise you, but not everyone has a credit score, and we don’t just mean children! You can get as old as 40 without any credit history at all, although such an individual would be quite rare. Your credit score only begins to be called into existence once a financial institution decides to evaluate your creditworthiness. And even then, your number cannot be generated if there is no financial history to speak of just yet.
To give you a better idea of just how that works, let’s take a look at what actually makes up your credit score.
(For consistency, in this article, we’ll only be referring to FICO when we talk about credit scores.)
There are three major credit bureaus in the U.S.: Equifax, Experian, and TransUnion. To judge a borrower’s reliability on paying loans, they all compute a credit rating they call your FICO score. This rating is named after the company that came up with it, the Fair Isaac Corporation.
This score is broken down as follows:
35% – Payment History
The whole banking industry is built on trust, and credit scores are just measures of our trustworthiness with money. They find this out to know how dependable we are when it comes to holding up our end of contracts, that is, making payments for our debts. This is why it’s important to make it a habit always to pay our bills on time. All those previous bank runs will help you buy a house one day.
30% – Credit Utilization
The next big chunk of your credit score is a ratio of all the amounts you owe put together. For a clearer picture, think of the limit on your credit card. Most of the time, you only use a fraction of the allowed limit the bank has granted you.
It is recommended that you keep your utilization as low as 30% if you can. When you have a $100,000 limit, that means owing $30,000 or less every month. Aside from helping your score, this gives you lots of leeways if you run into an emergency expense.
To compute for your credit utilization, the bureaus add up all of your debts and divide this with all the available credit lines you have been given.
15% – Length of Credit History
Another aspect that shows how reliable you are with payment is the length of time you’ve built a relationship with each lender. Although your biological age does not factor into your credit score, it does contribute in some way if you have had lots of credit activity for a certain period of time. For instance, a younger person might score lower on this component than an older person who has held different credit accounts for years.
For financial institutions, the shorter your history, the lower credit you get. Lenders consider the tenure of each line of credit in your profile.
10% – Credit Variety
It also matters to lenders what kind of retail products you can use to give further insight into your money habits. It’s not enough to only have credit cards. It can also be helpful to have other types of loans such as mortgages. This gives a reflection of your experience borrowing from financial institutions.
10% – New Accounts
Finally, your credit report will also detail the instances of credit inquiries, such as when a bank agent requested for your history due to a loan application. You can also make an inquiry on your own just for information, which will not affect your rating.
To calculate your credit score, the last component is assessing your most recently opened lines of credit. Banks consider it to be worrying if there is a sudden flurry of activity in your credit report as this can indicate risk. This is another area where your biological age can have a bearing on your score. People in their earlier working years tend to open more accounts than older people nearing retirement.
How Bad is Bad Credit?
There’s a false belief that people start with a zero credit score. Nor is it possible for anyone’s rating to plunge this low no matter how poorly they manage their debts. But how low is a low credit score?
FICO scores start at 300 on the lowest end, with 850 as the highest score. If you’re somehow worried that your score might linger near the deeper end, there’s no need to stress yourself. According to FICO’s principal scientist, Tommy Lee, a score of 300 is infrequent.
Even so, a meager credit score is not an accurate depiction of your recent financial behavior. It can simply mean that there’s not enough data in your credit report to generate a figure. Remember, more than a third of your rating is all about payment history, and you clearly cannot pay off debts that don’t exist just yet.
Can I Get a House with Bad Credit?
When you want to buy a house, it is wiser to turn to mortgage lenders than paying in cash upfront. This gives you better liquidity and lets you take advantage of an impressive credit score. But what do you do when you do have bad credit? And what does a bad credit score mean when applying for a mortgage?
A mortgage is a home loan you apply for when you need financing for real estate. The type of mortgage people can qualify for depends on their credit scores.
You either get a government-insured loan or a privately backed mortgage.
Here are just a few of your options:
1 – VA Loans
Two loan options feature zero down payment. VA loans are one of them. This home loan strictly requires that a borrower be an active duty service member or spouse to qualify for a VA loan overseen by the U.S. Department of Veterans Affairs (VA). Because this is a hard-earned benefit of our military, there is no minimum credit rating required for application. However, the VA itself will not issue the loan, and the mortgage lenders who make review applications often define the minimum credit score.
2 – USDA Loans
Home loans backed by the U.S. Department of Agriculture (USDA) are the second loan type that does not ask for a down payment. A USDA loan is a more accessible loan program to avail. You can qualify for a mortgage if you are buying a house in a rural area. (See this link to check for property eligibility.) However, you will need to have a minimum credit score of 640 to get approved.
3 – FHA Loans
When you don’t qualify for a loan from the VA or USDA, you can next take a look at FHA loans. This home loan is insured by the Federal Housing Administration (FHA), and they were specifically created to give opportunities to Americans who have lower credit scores. That is, with a credit rating of 580, you can be eligible for a home loan 96.5% of your house’s purchase price. For a minimum credit score of 500, you will need to put up at least a 10% down payment to avail this mortgage type.
4 – Conventional Loans
Finally, if you have the capacity to make a larger down payment, this will most likely mean that you have a stronger credit score, and these factors can help you qualify for a conventional loan. You will need a credit rating as good as 620 to avail of one. Conventional loans are offered by private mortgage lenders who Fannie Mae and Freddie Mac scrutinize.
The lenders set the qualifications for borrowers, but you can typically make a minimum down payment of just 3% if you meet credit score requirements. When you are concerned by private mortgage insurance–which is understandable because nobody wants further expenses–you can make a bigger down payment of 20% to get off mortgage insurance scot-free.
Credit Scores Below 500
For Experian, a credit score ranging from 300 to 579 is considered “Very Poor.”
When it comes to buying a house, below 500-bad credit home loans are just impossible. However, as we have previously discussed, several factors go into determining your score. Applying for a home loan with bad credit may seem out of the question, but there are ways of improving your credit rating. You might even want to check your credit report to make sure there aren’t any errors. In fact, it’s more common than you might think!
How to Improve Your Credit Score
It will take some time and patience, but you can feasibly expand your loan options within a year by working on your credit rating with enough determination.
Here are a few ways to do it:
1 – Get a credit card
Many people try to avoid credit cards like the plague, and these people are surely missing out! There’s a lot to be said about earning air miles and points on transactions you have to make anyway, like grocery shopping. When you always pay using cash, you can pay for the benefits that credit card users can make. Utilizing these cards is a sure way to build a good history and improve bad credit. If you have difficulty applying for one, you can always get one of those secured credit cards linked to your savings.
2 – Pay your bills on time
We’ve said it before, and we’ll repeat it. It’s essential to pay off your responsibilities before their deadlines. Besides helping you dodge interest rates on revolving debts, this will raise poor credit in no time, keeping in mind that payment history is 35% of your credit rating.
3 – Correct errors in credit reports
If you are one of the increasing numbers of people who have been discovering mistakes in their credit reporting, it is of paramount importance that you work on this as soon as you can. Remember, you deserve better than this!
See here for the official steps you can take as advised by the Federal Trade Commission.
There’s no way to escaping this truth in life, that to become eligible for loans, one must satisfy an abstract number. Still, it’s simply a matter of when you can bring your application to lenders once you’ve raised yourself from the throes of bad credit.
There’s surely nowhere to go but up! Now’s just the time to reflect on how you can improve your situation. America is still the land of opportunity, and here, your future is in your hands.