The Federal Housing Administration (FHA) loan is often referred to as a first-time homebuyers' loan,…
What is the ideal credit score for home loan applications?
If you have a 725 FICO Score, this is a very good credit score to buy a house. But you don’t actually need to get your FICO rating this high to assure yourself of at least two options.
Whether you are still single or already have a family, everyone has their own picture of their ideal house. Sad to say, however, not everyone has the opportunity to buy a house with money right out of their pocket. With the home prices that we currently have, it might take years or even decades before you can save the kind of cash needed to pay a house in full upfront.
It’s a good thing that mortgages exist. The thing to remember about home loans, though, is that you need to have the right credit score to qualify for a loan. For example, do you know the minimum credit score required to buy a house in 2021? And if there is an ideal home, is there an ideal credit score you should have if you want to apply for a mortgage? In this article, we hope to answer these questions.
Credit Scores: What’s the big deal?
Imagine that your friend is going through a difficult time, and your friend is now approaching you for financial help. Will you be willing to let your friend borrow money? What if this money involves a big chunk of your own savings?
The mortgage industry is a huge business. Mortgage lenders can earn money from borrowers through the interest they are obligated to pay over several years. If a borrower defaults, lenders can get the house and recoup the losses by reselling it. But because they are lending a serious amount of money indeed, as much as possible, lenders need to make sure that they are only accepting the right kind of borrowers. To determine this, they use the concept of a credit score.
Now, let’s go back to your friend who’s trying to borrow a lot of money. You might decide that it’s worth lending this person your money because, after all, you know this person. There is already enough trust in the relationship that you’d be open to the idea of taking this risk.
On the other hand, the mortgage lender and the borrower are oftentimes strangers. There is no history between the two parties considering that trust needs to be established in a short period of time.
Your credit score is essentially a portrait of your existing history with debt. Therefore, this prior relationship will give the mortgage lender a very good idea of where you are in your finances. Furthermore, they’ll also have an idea of just how much money you’d be able to repay and just how much risk they are taking that can translate to the interest rate you will get.
Mortgages: What’s the minimum credit score to buy a house?
The short answer to this question is actually no credit score at all. However, this doesn’t mean zero.
FICO Scores actually start at 300; this is the lowest FICO Score that you can get. The highest FICO Score there is an 850 rating. So we say that there is no minimum credit score needed to buy a house because borrowers can actually get a mortgage even if they’ve never had credit cards, never paid in installments, or even opened a savings account. But, unfortunately, it can be very tough to apply for a mortgage in this kind of situation because your credit history will have to be manually underwritten.
Most people will, however, be able to generate a score. According to the numbers, more than half of Americans will have at least one credit card, which automatically means that they will have existing histories filed with credit reporting bureaus. And although it’s going to be very, very hard to qualify for a mortgage with rock bottom credit scores, it is, at the very least possible.
If you want to apply for a mortgage without worrying about minimum credit score requirements, you will need to look at houses way out of populated cities.
The U.S. Department of Agriculture, in a bid to encourage more people to buy houses in the countryside, insures a rural housing loan called the USDA loan.
If you’re getting this mortgage, it can be for the following reasons.
- You really don’t have enough savings to make a down payment for a mortgage. A USDA loan is also called a zero down payment mortgage. You will only have to worry about the closing costs of any home loan out there.
- You’ve really been down in the dumps in terms of finances. In which case, you will want to prepare for the manual underwriting coming your way. You want to show every single piece of paperwork you can collate that will give feedback about your money situation. No matter how dire your situation is, this will actually work to your advantage. The USDA gives special consideration to disadvantaged Americans if they can show the ability to overcome their situation.
If you really want to talk about the minimum credit score needed to buy a house, the actual number is 500 because this FICO Score is the bare minimum for a mortgage loan anywhere in America. We say bare minimum because even with 500, FHA loans are not guaranteed.
There are many lenders with additional overlays. For example, maybe you meet the minimum credit score requirements, but you don’t have the right debt-to-income ratio, or they don’t think your employment situation is stable. There can be several reasons. And another thing you have to think about, even if you already have a score of at least 500, is you need to put 10% down.
For an FHA loan, if you have a score of 500 to 579, you need to pay 10% for a down payment. But if you have a score of at least 580, you can secure your loan for as little as a 3.5% down payment.
The Federal Housing Administration also allows borrowers to get down payment funds from other sources. For example, you might get gifted by friends or family, or you might approach down payment assistance programs. With FHA loans, this is totally okay.
The only caveat for this type of loan is really the mortgage insurance premium (MIP). You have to pay for MIP for the whole life of the loan. For this reason, a lot of people eventually refinance to get a conventional mortgage.
USDA loans and FHA loans are what are called government-backed loans because government agencies insure these. These are fallbacks if borrowers have lower credit scores and are willing to compromise to get closer to their homeownership dream.
The opposite of government-backed loans is conventional loans. Although Fannie Mae and Freddie Mac regulate these, they are not insured by the government. Instead, they are guaranteed by private investors, which is why instead of MIP, you pay for what’s called private mortgage insurance (PMI).
For a lot of borrowers, PMI is a lot more preferable compared to MIP. With FHA, MIP is forever, but with conventional, you have the opportunity to skip it entirely. For example, if you can make a 20% down payment, you don’t have to be charged PMI at all. However, if you make less than 20 percent, you have to wait until you gain 22% home equity because, after this, PMI automatically falls off.
This type of mortgage, though, is meant for more experienced borrowers. The absolute minimum credit score you can have that will let you get approved for a conventional loan is 620, keeping in mind that sometimes even if you already have 620, there are still lenders who will not approve you for this kind of loan.
If you previously only qualify for an FHA loan, you can improve your credit score while you are paying off this initial mortgage. Once you have a higher enough credit score, you can renegotiate with your lender to get a conventional loan. Depending on how far along you are with your payments, you might no longer be charged for PMI. Just remember that you’ll have to weigh your situation since a refinance will come with its own closing costs.
Finally, there is also a mortgage insured by the Department of Veterans Affairs. Since these are meant exclusively for our veterans and their eligible families, many people will not be able to avail themselves of them.
However, if you do qualify for VA loans, you stand to enjoy the benefits of the other three types of mortgages we’ve mentioned, without a lot of the disadvantages.
For VA loans, you don’t need to make a minimum down payment at all, and there is also no monthly insurance you need to pay to assure lenders. However, when you secure the loan, you initially have to prepare for closing costs and the VA funding fee. This starts at 2.3% of the total loan amount, depending on your entitlement.
To qualify for a VA loan, applicants will typically need to have a score of at least 640, but this doesn’t go for all lenders. You can still find lenders who will approve you at a lower credit score if you can make up in other areas, like still making a down payment or having stable employment.
Applications: What’s ideal?
Now that you know a lot more about mortgages and credit scores, you can understand what we mean when we say that there’s a different mortgage for everyone. This is because each loan type suits particular needs and backgrounds, and every borrower who tries to apply has a different idea of the perfect home to settle in.
The ideal credit score for you depends on the house you need to buy, the industry where you work, or the amount of savings you have in the bank.
It is also pretty clear that you don’t need to have an exceptional FICO credit score to get approved for these financial products. With a score of 620 or higher, you will most likely be approved for almost any mortgage you want.
Just remember, it’s not just about your credit score. Preparing for a mortgage also means raising your income and lessening your other debts. So don’t miss the forest for the trees! We know you can do it!