Many adults who pay rent might be able to afford mortgage payments, but switching from renting to owning a home is a process that requires planning and forethought. If you’re considering applying for a mortgage loan, one of the first things you want to pay attention to is your credit report and score. Ask yourself, “Is my credit score good enough to buy a house?”
To help you figure out if your credit score is high enough to score you favorable terms on your mortgage loan, GOBankingRates.com asked financial experts to weigh in. But first:
Why Do Mortgage Loan Lenders Look at Credit Scores?
Credit scores “show a customer’s diligence in managing their debt load [in a timely fashion] with their obligations,” said Staci Titsworth, regional manager for PNC Mortgage. If a prospective borrower has a high credit score, it could indicate to the lender that the borrower is reliable and disciplined — meaning it’s less likely they will miss a mortgage payment.
“Mortgage lenders take a huge risk when they lend money for mortgage loans,” said Harrine Freeman, financial expert and CEO of H.E. Freeman Enterprises. “So, they want to make sure the person they lend the money to is able to pay it back.”
Remember that mortgage lenders, such as banks and credit unions, are in the business to make money and minimize losses. If you have a low credit score, that could mean you’re a risk. As a result, a lender might a) not grant you a mortgage loan or b) give you a loan with unfavorable terms, such as a high mortgage rate. Therefore, it’s extremely important that you try to improve your credit score before buying a house.
Related: 7 Common Myths About Home Buying
What Is a Good Credit Score for Homebuyers?
Your credit score, if using the popular FICO Score model, ranges from 300 to 850. Typically, the lower the credit score, the higher the cost for the homebuyer. Although borrowers with credit scores as low as 580 could qualify for an FHA loan — a mortgage insured by the Federal Housing Administration — their mortgage interest rates will likely be higher than those given to borrowers with credit scores in the 700s and up.
“720-740 is a good goal for a credit score to get the best rates on a home loan,” said Andrea Woroch, consumer savings expert for Lending Tree. But, “anything below 500 — it’s going to be really, really difficult and really expensive to get any type of a loan,” she added.
It’s important to note that each lender is different, however. What might be a “good” credit score at one lender might not be seen as “good” by another. Also, each lender looks at a variety of factors — your income, debt-to-income ratio, debt-to-loan (LTV) ratio, etc. — when approving (or denying) mortgage loans and establishing the terms.
Nevertheless, to help you gauge where you might stand in mortgage lenders’ eyes, Freeman provided a rough credit score scale below, ranging from “excellent” to “bad” credit:
|Type of Credit||Credit Score Ranges|
|Excellent||740 and above|
|Bad||599 and below|
With a credit score of 740 and above, you’ll likely be seen as someone who has excellent credit, both Freeman and Titsworth agreed. You’ll probably get approved for a mortgage loan. But, said Freeman, that’s not a guarantee. And if you do get approved for a mortgage loan, you might not get offered excellent mortgage rates.
“An excellent credit score is a huge factor, but you still might not get the best deal,” said Freeman. That’s because your lender takes into account other factors in addition to your credit score.
For example, if you have an excellent credit score of 740 but have a very high debt-to-income ratio, you might get denied a mortgage loan. Your “debt-to-income ratio has everything to do with the lender’s overall decision to lend the loan,” said Titsworth.
The debt-to-income ratio is a calculation that mortgage lenders use to determine a person’s ability to pay their monthly mortgage payment and repay their debts. You can calculate this ratio by dividing your monthly debt by your gross monthly income. “Twenty-eight percent is a good rate,” said Freeman. “Most lenders use a rate of 36 percent; some lenders go up as high as 43 percent. But, you really don’t want your debt-to-income ratio past 36 percent.”
If you have an excellent credit score, chances are you’ve been good about paying off your debts, and your debt-to-income ratio might already be well below 36 percent. Still, make sure that your 740-and-above credit score is coupled with a low debt-to-income ratio to improve your chances of getting a mortgage loan with a lower interest rate.
If your credit score is somewhere between 680 and 739, you have good credit. And, chances are high that you’ll qualify for the mortgage loan you want with a fair interest rate.
But obviously, like those with excellent credit, you’ll need to have more than just a good credit score to get the very best deal. “Just because you have a good credit score, that doesn’t mean you’ll get the best rate because if your debt-to-income ratio is high, you may not get approved,” said Freeman.
You might have fair, or average, credit if your score is somewhere between 660 and 679. You likely won’t get a mortgage loan with favorable rates like you would if you had a good or excellent credit score. But as long as your debt-to-income ratio remains low and you have a larger equity position, which means you can afford a larger down payment, you stand a good chance of getting approved for a mortgage loan with decent interest rates.
If your score is between 600 and 659, you have poor credit. Compared with those with good, excellent and fair credit, you’ll likely have a tougher time getting approved for home loans and lower mortgage interest rates. If that’s the case, you might want to turn to FHA loans. “You can get an FHA loan in that credit score range, from 580 to 640,” said Freeman.
FHA loans “allow people with a low score of 580 — which wouldn’t really qualify a lot of people with regular lenders — to actually get a loan,” said Woroch. “So, it’s kind of one of the lower credit scores we see that tend to still qualify.”
But “if your score is in the 580 range, you will have to make a larger down payment,” said Freeman. “So generally, with FHA loans, you make a 3 percent down payment. But if your score is lower than the requirement or is lower than 580, you’ll have to make a 10 percent down payment.”
Can you buy a home with bad credit if your score is 599 and below? Yes, thanks to FHA loans and subprime mortgage loan lenders, said Freeman. Subprime mortgage lenders give loans to people who have low credit scores. But as reported by the Wall Street Journal, many mortgage lenders want borrowers who have a solid credit history.
Besides, getting a mortgage loan with bad credit or a subprime mortgage loan could mean bad things for your bank account. “You don’t want to go that route because your interest rate is going to be really high,” said Freeman. “You may have a balloon payment, you may have to take a first mortgage and a second mortgage — you really don’t want to go with that option.”
Keep Reading: 8 Ways Creating a Budget Will Improve Your Credit Score
How to Buy a Home With Bad Credit
So the answer to the question, “Is my credit score good enough to buy a house?” is, “Possibly.” No matter what your credit score, there is a possibility that you can get approved for a mortgage loan — as long as all of your ducks are in a row and you don’t have a pattern of missed payments and other financial no-no’s.
For example, if your credit score is low because of one incident that hurt you financially, such as a divorce or a job loss, mortgage lenders will tend to look at the bigger picture before deciding, said Titsworth. That means they also take into account your lower debt-to-income ratio and/or your lower loan-to-value (LTV) ratio.
“What the underwriters are looking for is an isolated situation that won’t recur,” explained Titsworth. “[They’re looking] for a thorough explanation from the consumer — what happened? What happened to cause the credit blemishes at this point in time?”
But if you have a bad credit score and can’t secure a mortgage with favorable terms, you can always take steps to improve your credit score. “The No. 1 things is to first check your credit report,” said Woroch. It’s advisable that you check your free credit report at the three credit bureaus — Equifax, Experian and TransUnion — at least once a year.
From there, Woroch suggests paying off your debt as quickly as possible, making all of your payments on time, keeping your credit cards open and avoiding taking out any new lines of credit. In a couple of months, you will see your credit score improve so you can buy the house you’ve always wanted.
5 Quick Ways to Raise Your Credit Score
Kimberly Rotter contributed to the reporting of this article.