Step 3: How to Understand Your Credit
How to Understand Your Credit History and Credit Score
Credit history and score are two of the most important consideration factors that lenders use to approve or deny their loan applications. But, this is not to say that someone with imperfect credit can’t get approved for a mortgage. In some cases, a borrower with imperfect credit may be offered a loan, but one with a higher interest rate, or the lender may require more money down, or advise the borrower to purchase a less expensive home. In this section of the guide, we will go over:
- Can I buy a home with bad or no credit?
- What kind of credit score do I need to buy a home?
- How to fix your credit score to buy a home?
Can I Buy a Home With Bad or No Credit?
In the world of mortgage loan approvals, the higher the credit score, the better. A high credit score helps ensure that the borrower gets the lowest interest rate on their home loan while a borrower with fair credit or worse may find it especially challenging to get approved.
Here is how your credit score can affect your interest rates and approval odds.
- Exceptional Credit (760+): Having a top-tier credit score will enable you to take advantage of the best rate available at the time.
- Excellent Credit (720-759): This type of credit will only impact your interest rate slightly, usually no more than 0.25% higher than the lowest rate.
- Good Credit (680-719): Good credit will affect your interest rate a little more. Typically, borrowers with good credit are offered loans with interest rates approximately 0.5% higher than the lowest rate.
- Fair Credit (620-679): This is where the divide widens in relation to the interest rate. Borrowers with moderate credit can expect to pay 1.5% higher interest than the lowest rate available.
- Poor Credit (580-619): It’s not impossible to get approved for a mortgage with poor credit, but borrowers can expect their score to cause them to pay rates anywhere from 2% to 4% higher than the lowest rate.
- Bad Credit (350-579): It’s a steep uphill climb, but some borrowers are still able to get approved with very poor credit, however, the interest rate they are going to get will be extremely high.
The ideal credit score for applying for a mortgage is 700 or above. While it is still possible to get approved with a score less than 700, the interest rate for borrowers with lower scores will start impacting the overall cost of owning a home.
If the borrower doesn’t have any established credit, the lender will require them to provide another means of creditworthiness. In most cases, the lender will want to see the borrower’s history of paying their utility bills, cable bills, phone bills, and other monthly expenses. So, while it is possible for someone to get approved for a mortgage with no established credit, it is more challenging than it will be for a person with an established credit history.
What Kind of Credit Score Do I Need to Buy a Home?
Different types of home loans have different credit requirements. For instance, for a conventional loan, the minimum FICO score for approval is 620. FHA loans are a little more lenient, but they also have limitations. The lowest credit score a borrower can have and still get approved for an FHA loan is 580. VA and USDA loans don’t have set minimums, but rarely are mortgages approved for applicants with credit scores lower than 580 in either case.
The average credit score for buying a house is 600 or above, so this means even an applicant with bad credit can get financed.
If you have imperfect credit, but you want to buy a home, all is not lost. Get copies of your credit reports and review them for inaccuracies. Simply disputing an incorrect piece of information can help raise your number once the negative information is removed. Once you have your score as high as it can go, get prequalified by your lender. This will tell you how much home you can afford, and it will also show sellers that you’re serious about buying.
Keep in mind that when you get prequalified, it is not necessarily a loan guarantee. Your credit score and history must remain the same or improve between the prequalification and the loan approval. Do not apply for new lines of credit or allow any of your accounts to go delinquent, or the prequalification will mean nothing.
How to Fix Your Credit Score to Buy a Home
When a lender reviews your credit, they are looking for certain factors, but some factors are more important than others. Knowing what lenders are looking for will help you to concentrate on the most important parts of your credit profile. Here’s a breakdown of what lenders look to most when deciding on a loan approval.
- Payment History (35%)
- Credit Utilization (30%)
- Age of Credit (15%)
- Different Type of Credit (10%)
- Number of Credit Inquiries (10%)
Because payment history is so important to lenders, you need to ensure that you do not miss any payments on your debt obligations. One way you can do this is by setting payment reminders for yourself through your bank. Or, you can arrange for your bills to be paid automatically from your bank account. If you choose this direction, schedule your payments to be made a few days before the due date to ensure the payment gets made on time and without error.
Another way to improve your credit is to reduce the amount of debt you owe. To accomplish this, you should stop using your credit cards. Next, you should review the interest rates for all of your credit cards and create a budget that allows you to pay more on the card with the highest rate. Once that card is paid off, start applying the extra money to the next card with the highest interest rate. By tackling your debt this way, you’ll save money and improve your credit steadily over time.
If you have missed payments in the past, then concentrate on getting your accounts current and keeping them current. The impact of those missed payments will soften the older they get.
Additional credit improving tips include:
- Keep the balances on revolving credit accounts as low as possible
- Pay off debt instead of moving it from card to card
- Do not apply for new credit cards if you do not need them just to increase your available credit
- Do not close paid or unused credit card accounts, because the older the accounts are, the higher they will make your credit score
Ruining one’s credit can happen overnight, but fixing it takes time. If your credit score is keeping you from getting approved for a mortgage, then focus your energy on improving it. Eventually, you will get where you need to be.