What’s the big fuss about credit scores? One of the most important factors of getting refinancing or financing for a home is your credit. When lenders consider lending you money for a home, they will check your credit history. What they find when they run your credit history will have a huge impact on your options for a home loan.
Your credit score doesn’t tell everything about you, but it shows two key things. Your credit can influence your chances of mortgage approval. The purpose of the credit score is to assess risk. Lenders consider people with higher credit scores lower risk borrowers.
The credit score influences loan terms. A better credit rating improves your chances of getting the home loan. Your credit score also impacts how favorable the interest rate will be on your mortgage.
How Is Your Credit Score Calculated?
Lenders rely on your credit score, sometimes called your FICO score, to evaluate risk. A higher credit score is deemed lower risk. If you have excellent credit, you are considered the lowest risk.
Your credit score is calculated on several critical factors. These critical factors are:
- Payment history – which is about 35% of your score
- Amount of money you currently owe – about 30%
- Credit history – about 15%
- New credit applications – 10%
- Type of credit used – about 10%
A Low Credit Score Might Disqualify You From A Mortgage
So what’s considered a good credit score? Generally:
- 720 and above is excellent
- 700 is good
- 680 is average, and
- 620 to 640 is usually the minimum to qualify for a traditional mortgage loan.
If you’re a home buyer with less than stellar credit, don’t be too discouraged. Lending institutions look at several factors when evaluating your mortgage application. Lenders require borrowers to have steady employment and income history, have a sufficient down payment and low debt. Another key factor is if you can really afford the mortgage loan you’re seeking – if your finances don’t support your payments, your lender could turn you down.
Higher Credit Score Could Lead To A Lower Interest Rate
Homebuyers don’t always realize the relationship between the interest rate and their credit score. Your credit score will have a huge impact on the mortgage interest rate of your loan. Buyers with better credit scores might qualify for lower interest rates.
Even a small increase of interest points could add up over the life of your mortgage. Use a mortgage payment calculator to calculate possible mortgage payments with different interest rates. You will find that even a few points can make a big difference over the life of your home loan.
Serious Illness Won’t Lock You Out of Home Ownership
There are actually several factors that make up your credit score. A fairly recent change is called your FICO Score 9. This version of the scoring algorithm could be particularly beneficial for anyone who has had a serious medical condition that dealt a major financial blow. Score 9 was designed to differentiate between medical and non-medical debt. That might be good news if you’re worried about your credit score after struggling to pay off mounting medical bills.
FICO® Score 9 treats medical bills sent to collections differently than other debts in the sense that it doesn’t impact one’s credit as much as non-medical debt.
You Can Boost Your Credit Score
For the best mortgage rate, it is best to plan ahead prior to applying. Step number one is to look at your credit score – is your credit history a little spotty? You can take the following steps if you want to boost your credit score.
Remember it might take some time for your new habits to be reflected in your credit score, so you may want to start now:
- Pay all of your bills on time – credit cards, car loans, student loans, utilities, and even your rent all matter.
- Don’t spend more than 30% of your limit on your credit cards. For example, if your card’s limit is $5,000, don’t spend more than $1,500.
- Pay off your high-interest, high-balance credit cards first.
- Don’t cancel your credit cards, even after paying off everything you owe on them. It helps to keep active lines of credit open.
Top Frequently Asked Questions From Home Buyers
How much mortgage can I afford?
Among other things, your income, savings for a down payment, and current debts determine how much house you can afford. A mortgage calculator can help you figure out how much you might want to spend on a house. An important metric lenders use to calculate how much you can borrow is the debt-to-income (DTI) ratio. DTI ratio is your total monthly debts to your monthly pre-tax income.
We calculate DTI by dividing gross monthly income by total monthly payments.
Let’s say you have a $4500 monthly income and your debt payments total $900 a month. Dividing $4500 by $900 gives you a DTI of 20%.
Most lenders will approve loans with a maximum DTI of 43%.
Before you get too deep into your house-hunt, it would help you to have a ballpark estimate of how much you can afford so that you can spend your time looking for homes that are in your budget.
Should I talk with a lender before I start house-hunting?
Yes, you should! Work with your lender to get a mortgage pre-approval. Pre-approval can help you narrow down how much you can afford. Additionally, talking to an expert mortgage professional can clarify any questions you might have. If you are a first-time homebuyer, check to see if the lender has a first-time homebuyer program. Talk with your lender to learn about the types of home loans available. For example, if you are a veteran, you may be eligible for a VA loan. Ask the lender about the pros and cons of fixed and adjustable-rate mortgages.
How many homes should I look at before choosing one?
Everyone is different. Some people fall in love with the first home they look at, while others look at dozens of properties before they decide on one. Buying a house is a big decision, so don’t feel bad if your search takes a while. On the other hand, if you get lucky and decide to buy one of the first houses you look at, there’s nothing wrong with that either.
Do I need a real estate professional?
Although it may be possible to buy a house without a real estate professional, having one should make the home buying process a lot easier. A real estate professional will guide you through the process and take care of many of the small details and provide you with advice to make sure that your home buying experience goes as smoothly as possible. Real estate professionals can represent you and your interests and can help you negotiate.
A real estate agent is paid commission from the proceeds of the house that you end up buying, so you, as the buyer, won’t have to pay the realtor fees.
What are some things I should find out about a potential property?
Many home buyers want to educate themselves about their target neighborhoods. What’s the economy like? What are the crime rates? Families with small children may want to know about the schools in the area. Speak with people who live in the neighborhood. Find out what they like or dislike about the neighborhood. Also, consider the utility bills because, on top of your mortgage payment, you will have to pay for your utilities, like electricity and water. Online research or your real estate agent can help you find this information.
Should I get a home inspection?
While it is important to research the neighborhood, it’s also important to know the condition of the house. A house may look great from the outside, but there could be hidden problems that were not mentioned in the listing or weren’t visible to you when you toured the home. A home inspection is a good idea. Types of inspections include, but are not limited to, home inspections, pest inspections, chimney inspections, and radon tests.
If you do find problems with the house, that doesn’t mean that you should immediately write off the house as an option. The seller may be able to resolve the issues, or you may be able to negotiate a lower price. Additionally, many homebuyers choose to do a final walk-through right before closing to ensure that everything is working as expected.
How is the offer process?
Once you find a home that is right for you, you have to make an offer. Your real estate agent can provide you with advice on strategies to make an offer, but ultimately, it’s up to you. The seller will then respond to your offer, which varies with how long it can take. Your offer will have a “life,” which is how long the offer is good for. This also depends on how long the house has been on the market, competing offers, and whether you are considering making other offers on other homes.
Your offer might be accepted, countered, rejected, or not responded to at all. If your offer is rejected, you can make another offer if you’d like. Once your offer is accepted, you should be able to enter escrow.
If you have any mortgage-related questions, don’t hesitate to contact a mortgage professional.