Buying A House: What Credit Score Do You Need?

The following is presented for informational purposes only and is not intended as credit repair or credit repair advice.

Homeownership is a dream for many people. No more landlord to answer to — the decisions for improvements are yours. Plus, owning your own home can provide stability by allowing you to become part of a community and invest in neighborly relationships. Along the way, you build equity in your home, strengthen your credit score, and come tax time, possibly qualify for a tax deduction.

But not everyone is well positioned to buy a home, especially if they have a poor credit score. Here’s what to know about credit scores for buying a home and how to improve yours.

Credit Scores That Mortgage Lenders Want to See

The baseline credit score that mortgage lenders will consider is a minimum score of 500 (read up on how a mortgage works). But that’s a low score in their view, and it will limit you to certain types of loans, likely with higher interest rates. To be able to access better mortgage products, a better minimum score is 620. For the best interest rates, 740 or higher is optimum.

However, the rules can be different for government-insured home loans, with added flexibility for lower credit scores. VA and USDA loans have no minimum credit requirement. FHA loans allow for an absolute minimum score requirement of 500, but scores at that level will require a down payment that’s 10% of the purchase price. That can be difficult for many new buyers. If your score is 580 or higher, you’ll be eligible for the maximum funding available for an FHA loan, which is 96.5% of the purchase price. The remaining 3.5% you’ll need to provide as a down payment.

Lenders Use Multiple Scores When Evaluating Applications

Mortgage lenders go further than credit card companies to determine if you’re a good risk for a mortgage. It’s useful to understand how they use your FICO® scores as you plan ahead.

Mortgage lenders typically want to see reports from each of the big three credit bureaus, along with a FICO score for each report. The big three are Transunion, Experian, and Equifax. The lenders will typically receive one report containing information from all three reporting bureaus, along with three different FICO scores. A FICO score is a number associated with the information in your credit reports. Scores likely vary because each bureau reports your credit history a little differently.

The mortgage lender may use the middle score for lending to you. So, if you need a minimum 580 score, your middle score might need to be at least 580. However, there are exceptions.

Besides FICO scores, mortgage lenders often look at the information in your credit reports as well when reviewing your application. For example, even if you have decent FICO scores, a lender could turn you down if they don’t like your debt-to-income ratio or see that you owe too much money to collection agencies. Other factors include loan amount, down payment, and location of the home.

Bottom line: a higher credit score benefits you in many different ways, but it’s not the only factor considered.

The Impact of Low Credit Scores on Interest Rates

While it’s true that all lenders are a little different, it’s standard for interest rates to be based largely on the range of your credit score. The higher your score, the lower the interest rate — and that means paying less money over the long haul for a house.

Check out this interactive chart by FICO to see the connection between credit score, interest rate, and monthly payment. The reason higher scores benefit you so much is that they demonstrate to lenders that you’re a good risk as a borrower. In theory, a high score is the result of successful borrowing in the past with regular and on-time payments. The converse is also true: a low score can be interpreted as you being a riskier borrower.

Of course, maybe you just haven’t borrowed much money, or you don’t have a portfolio of different types of credit. That can result in a low score even though you haven’t been irresponsible with credit cards. But to lenders, that’s a risk to them because they don’t have evidence for well-managed borrowing behavior. And the riskier the borrower, the more lenders will try to minimize the risk to themselves with a higher interest rate and other possible terms that are costlier to the borrower.

How to Buy a House If You Have a Poor Credit Score

So, what can you do if you want to buy a house but have a poor credit score? There are a few steps you can take, including improving your credit score. That takes time but it may be the optimal path, depending on just how low your score is.

You can also explore any government-insured loan programs that you may qualify for (FHA, USDA, VA). Those programs may qualify you to buy a house more quickly.

Homebuyer assistance programs are primarily run at the state level. Check out the programs available in your state. At the federal level, the FHA is the largest insurer of homes in the world. It’s a great place to start as long as your credit score is at least 500.

How to Improve Your Credit Score

Improving your credit score doesn’t take anything complicated. Mostly, it takes discipline and consistency over time. Here are the best ways to improve your score.

• Make on-time or early payments, and never miss one. In most scoring models, on-time payment history is the single most important factor in your credit score.
• Reduce your overall debt to increase available credit. That means paying down active credit cards and keeping those balances low. The larger your balance compared to the available credit, the worse it can be for your credit score.
• Avoid too many recent credit inquiries. For example, if you try to open new cards, and they conduct a credit inquiry, that can ding your credit score. Minimize those inquiries.
• Try boosting your score with alternative data, such as rental payment history and utility payment history reported via a credit reporting service. Keep in mind, some of these credit-boosting services cost money, ranging from $6.95 to $8.85 per month, sometimes with a startup fee. And they may not impact the specific credit scoring model that your lender is using, but, still, alternative data is a potential option to explore. You’ll have to decide whether the monthly fee is worth a credit score bump.

Are you concerned your credit history and score are keeping you from your dream of homeownership? Buying a home isn’t a quick process. If you want to improve your credit score, work with a certified credit counselor to find ways to reduce debt, build savings, and improve your credit health. Credit counseling from MMI is free, confidential, and available online or over the phone.