How Do Credit Scores Impact Buying A Home?
When reading tips for first-time home buyers, it's fun to dream about things like modern kitchen designs and hardwood floors. (You might also have nightmares about water damage and leaky roofs, but that's what the home inspection is for.) However, before you can begin focusing on those items, you need to understand how your financial situation affects your ability to purchase a house. Determining how much home you can afford and saving for a down payment are necessary early steps to take.
You may also hear advice about strengthening your credit score. Just how important is this score when you're trying to buy a home? It's not important if you're fortunate enough to be able to pay cash for the house. Because you don't need a loan when paying cash, no one involved in the process will probably even look at your credit score. Paying cash isn't common, though, as roughly 75% to 80% of people finance the purchase of the house with a mortgage loan.
When you need to obtain a mortgage, your credit score is vital. The credit score affects the interest rate you'll pay for the loan. If the credit score is too low, you might be unable to obtain a mortgage at all. Mortgage lenders will also pay attention to your current debt level and income, the amount you have in savings, and your overall credit report. However, because the credit score is a reflection of your success rate in borrowing and paying back money, it's a substantial part of obtaining a home loan.
How to know whether you have a good credit score for buying a home
The scale for a credit score assigns you a rating between 300 and 850. Higher numbers indicate a better rating. Three credit bureaus issue the scores – Equifax, Experian, and TransUnion. Your score might vary a little among the three credit bureaus because they may emphasize different information. Perhaps one is emphasizing the FICO scoring model, while another is focusing on VantageScore. You shouldn't have to worry about slight differences, as mortgage lenders generally look at the numbers from all three bureaus and use the middle one.
What is a good credit score to buy a house? If you want to secure the lowest possible interest rate on your loan, a score of 750 or higher is beneficial. The minimum credit score to obtain a conventional loan is usually 620, while you'd need a minimum score of 600 for an FHA-type loan. People with credit scores of close to 620 might not receive the most favorable interest rates, even though they qualify for a mortgage. A prospective homebuyer with a credit score as low as 580 might find a subprime loan, but they'll have limited options and the highest interest rates.
Why do borrowers with poor credit struggle to obtain favorable terms on mortgage loans? Lenders believe the credit score provides an indication of how likely you are to repay the loan. Lenders see someone with a lower score as a risky borrower.
What homebuyers can do if their credit scores are too low
One of the key things to know about getting a mortgage is checking your credit score before you apply. You can check your credit score in a few different ways. If you have credit cards, the company might print your score on your monthly statement. Financial counselors or the reporting companies may provide you with a free credit score. Even if your credit score isn't as high as you'd like, you could still apply for the loan now and pay the higher interest rate. However, an interest rate that's 1% higher on your mortgage loan could increase the total interest paid over the life of the loan by several tens of thousands of dollars.
A better option is saving more for your down payment. If you have a larger down payment, lenders will often give you a lower interest rate. Conventional loans typically require a down payment of at least 5%, whereas some loans may require 10% upfront. Bankers often recommend using a 20% down payment.
Taking steps to improve your credit score can require from 1 to 12 months. One of the fastest ways to make improvements is to check for errors. Request copies of your credit report and correct any inaccuracies through the bureau. To achieve improvement over a longer period, always pay your bills on time and keep your existing loan balances as low as possible. However, avoid opening new accounts in the months before you plan to apply for a mortgage.