In most cases, maintaining a strong credit score is the most important thing you can do to ease your mortgage application process. You credit score and report help your lender determine your ability to pay back your home loan. Therefore, your lender will take into account your score and report when assessing whether to offer you a mortgage loan and when calculating your rate and terms.
The terms credit score and credit report are often used interchangeably, but there is a difference.
A credit score is a score between 300 and 850 representing the creditworthiness of a borrower. A score of 670 or more is generally considered good. A score of 740 or more is considered very good. A score of 800 or more is considered excellent. Most scores fall between 600 and 750, and the national average is around 695. Most lenders look at the borrower’s FICO score, which is based on consumer credit files of the 3 national credit bureaus, Experian, Equifax, and TransUnion. According to FICO, credit scores comprise payment history (35%), level of debt (30%), length of time the borrower has had a credit history (15%), types of credit used (10%), and any recent credit enquiries by a bank or other lender (10%).
A credit report is a detailed report of all a borrower’s credit information. It contains information on balances, delinquent payments, bankruptcies, and credit inquiries. Your credit report provides lenders with a detailed picture of how your credit score was calculated.
Your credit score can affect your mortgage application in 2 ways: it can determine whether or not you’re accepted for a loan, and it can determine what rate the lender is willing to offer you. For a conventional loan, most lenders require that a borrower have a credit score of at least 620 and that their down payment be at least 20% of the value of the loan. But if your credit score barely meets the 620 threshold, you’re likely to be offered a poor interest rate and annual percentage rate (APR) and be liable to make higher payments over the course of the loan. As the table below demonstrates, the higher your score, the better off you’ll be. In this theoretical example, a lender would be willing to offer you an APR of 3.49% based on a credit score of 760. But with a credit score of 620, it would only be willing to offer you an APR of 5.08%, meaning you would pay an additional $94,000 to your lender over the course of your 30-year fixed-rate mortgage.
For home buyers whose credit score is lower than 620 or who are unable to make a 20% down payment, there is another way of getting into the housing market: an FHA loan. Buyers with a credit score of 580-619 are eligible for an FHA loan with a minimum 3.5% down payment. Buyers with a credit score of 500-579 are eligible for an FHA loan with minimum 10% down payment. If a buyer has no credit history, the lender will ask for other financial history to assess the application, such as insurance payments and electricity and phone bills. The one major catch of an FHA loan is that the borrower must pay monthly private mortgage insurance, at least until they have paid off more than 20% of the value of the loan.
Active and former members of the U.S. Military, National Guard, and Reserve, and spouses of veterans who died in the line of duty are eligible for VA loans, subject to other requirements. The minimum credit score for a VA loan is 620. Because the government guarantees up to a quarter of the loan (up to a maximum of $113,275), lenders are willing to offer lower interest rates, lower down payments, and to forgo mortgage insurance, making this an attractive option for eligible borrowers with a lower-than-average credit score.
Your credit score can impact not just your mortgage application but also any other application for credit, such as a credit card or personal loan. It can also impact your homeowners’ insurance premium once you purchase a home. Insurance companies use a credit-based insurance score to help them evaluate the likelihood that a borrower will file a claim. The better your score, the lower your premium will likely be. The worse your score, the higher your premium will likely be.
When a lender or lenders check your credit report, it temporary reduces your credit score. Fortunately, the various credit agencies consider multiple inquiries made within the same 45-day period to be one inquiry. Therefore, if you’re planning on applying to more than one lender (i.e. to one lender for a mortgage and to another for a car loan) you’d be best served by doing so within the same 45-day period. Another thing many borrowers aren’t aware of is that they can check their credit score without being penalized. Under federal law, every borrower is entitled to a copy of their credit report every 12 months. To obtain a free credit report from all 3 credit reporting agencies, just go to Annualcreditreport.com. To get your FICO combined score for free, head to FICOScore.com.
There are several things you can do to improve your credit score. The first thing is check your credit report and to inform the relevant credit bureau if you notice any errors. Another simple thing you can do is setup payment reminders so that you make all your payments (i.e. loan payments, credit card payments) on time. If you’re able to, a third thing you can do right away is to pay off any debt you owe.
If your credit situation is really bad or if you’re unable to make payments or pay off debts, another option is to contact your creditors or to see a credit counselor. Although this won’t impact your credit score immediately, it’s always preferable to seek assistance rather than find yourself slipping into even more debt and eating away at your credit score.
Finally, if you’re concerned about protecting your credit score, don’t open more credit accounts than you need. Having credit cards and loans is a good way of building a credit score, but if you have too many credit accounts and you find yourself struggling to manage all of them – it will likely do more damage than good.