Lenders take numerous factors into account when assessing mortgage applications, but the most important factor of all is personal credit scores. Your credit score is an indicator of your ability to pay back your loan, hence why lenders look at it closely before deciding whether to approve or reject you and whether to offer you a low or high-interest rate.
In this article, we look at how credit score can affect your mortgage approval. Plus, we offer tips on how to improve your credit score to get better offers from lenders.
A credit score is a score between 300 and 850 representing the creditworthiness of a borrower. Most scores fall between 600 and 750, and the national average is around 711. The term credit score is used interchangeably with FICO score, which is based on consumer credit files of the three main credit bureaus, Experian, Equifax, and TransUnion. According to FICO, credit scores comprise payment history, level of debt, length of time the borrower has had a credit history, types of credit used, and any recent credit inquiries by a bank or other lender.
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.
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Your credit score can affect your mortgage application in two ways: first, it determines whether or not you qualify for the loan; and second, it determines what rate the lender is willing to offer you.
For conventional loans, 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 high-interest rate, translating to higher monthly payments for the duration of the loan.
For home buyers whose credit score is lower than 620 and 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 a 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. 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 home value.
Based on a $200,000 30-year fixed loan in California. Source: myFICO, August 11, 2023
Federal law entitles you to a copy of your credit report once every year from all three credit reporting agencies – Experian, Equifax, and TransUnion. Each of the three agencies collects and records information in different ways and may not have the exact same information about your credit history. Checking up on your credit reports is important because you can check them for accuracy and alert the relevant agencies to any missing or incorrect details.
To obtain a free credit report from all three credit reporting agencies, go to Annualcreditreport.com or call 877-322-8228 (877-FACTACT). Alternatively, you can complete the Annual Credit Report Request Form and mail it to: Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348-5281. To view your FICO combined score and find out whether your credit is good enough to apply for a mortgage, head to FICOScore.com.
In 2020 FICO, the company that designs the credit scoring models used by most American lenders, announced the release of a new scoring model putting more emphasis on late payments and debt than previous models. With this in mind, here are the ways to maintain a strong credit score or improve a poor credit score:
Income, down payment, and loan amount are all important factors in determining your borrowing ability, but no factor is more important than credit score. Strong credit isn’t just key to getting approved, it’s also key to getting a good deal. As we showed above, having excellent credit could save you $200-$300 on your monthly payments. With a good dose of financial discipline and commitment, the best mortgage rates can be within your reach.