Your credit score plays a major role in your ability to secure a mortgage loan. Not only does it impact your initial qualification for a loan, but it also influences your interest rate, down payment requirements, and other terms of your mortgage.
Are you considering buying a house, and making sure your credit is ready? Here’s what you need to know.
- While some mortgages require minimum scores as high as 640 (conventional loans), others go down to 500 (some FHA loans).
- Your credit score impacts the costs of your loan; a higher score means that you're likely to pay your bills on time and that you can qualify for lower interest rates.
- Most lenders use a “tri-merge” credit report showing details from multiple credit bureaus.
- Others may use a “residential mortgage credit report,” which includes other details about your financial life, such as rental history or public records.
How Your Credit Score Impacts Your Mortgage Prospects
If you’re planning to buy a home, your credit score will play a big part in the process. At the start, it will determine which loan options you can even consider as a homebuyer. While some loan types require minimum scores as high as 640 (conventional loans), others go down to 500 (some FHA loans).
Your credit score will also impact the costs of your loan, because your credit score represents your level of risk to a mortgage lender. A higher score means you pay your bills on time and can be expected to repay your mortgage just the same. As a result, you’ll qualify for lower interest rates.
If your score is low, however, that means you’re a risky bet for a lender. To compensate for the extra risk—that chance you won’t pay your loan or might foreclose on the house—they’ll boost the interest rate to protect themselves.
Suppose you’re purchasing a $250,000 home in Texas and putting 10% down. In 2019, according to the Consumer Financial Protection Bureau, your interest rates would most likely look like this:
|Effect of Credit Score on Loan Rates (2019)|
|Credit Score Range||Interest Rate|
|620 to 639||5.25% to 5.99%|
|640 to 659||4.125% to 5.875%|
|660 to 679||4.0% to 5.625%|
|680 to 699||3.875% to 5.625%|
|700 to 719||3.75% to 5.5%|
|720 to 739||3.75% to 5.125%|
|740 to 850||3.625% to 4.99%|
The difference in interest paid over the life of the loan could be substantial. On this specific loan amount, just a one-percentage-point difference (3.625% vs. 4.625%) would equal more than $11,000 less in interest over the first five years and nearly $50,000 less across the 30-year loan term.
The Impact of COVID-19
With historic low interest rates as a result of the COVID-19 pandemic, credit scores may have less of an impact on your loan rates than they would in a typical economy. Consider the same scenario from above in the current climate of 2021:
|Effect of Credit Score on Loan Rates (2021)|
|Credit Score Range||Interest Rate|
|620 to 639||2.250% to 3.875%|
|640 to 659||2.250% to 3.875%|
|660 to 679||2.250% to 3.875%|
|680 to 699||2.250% to 3.875%|
|700 to 719||2.250% to 3.875%|
|720 to 739||2.250% to 3.875%|
|740 to 850||2.250% to 3.875%|
While the pandemic has had a large impact on interest rates, it's not something you can count on year after year. For that reason, it's still important to understand how your credit score can affect your loan interest rate.
Credit Score Requirements by Mortgage Loan Type
There are four main types of mortgage loans:
- Conventional loans, which are backed by Fannie Mae and Freddie Mac
- FHA loans, or those from the Federal Housing Administration
- USDA loans, which are designated for rural properties and are guaranteed by the U.S. Department of Agriculture.
- VA loans designed for military members and veterans
Each of these loans has different credit score requirements. Here’s how they break down:
- FHA loans: Minimum 500, with an average score of 680
- Conventional loans: Minimum of 620 to 640, depending on the type of loan
- USDA loans: Minimum 580 though 640 preferred
- VA loans: No credit score requirement
On FHA loans, your credit score is directly tied to the down payment you’ll be required to make. If you have a score of 580 or above, you’ll need to make at least a 3.5% down payment. If it’s 579 or lower, your down payment will need to be at least 10%.
What Kind of Credit Report and Score Do Lenders Use?
To offset their risk and ensure they’re getting the most accurate picture of a mortgage borrower, most lenders will use what’s called a “tri-merge” credit report showing credit details from multiple credit bureaus.
Inrtead, they may use a “residential mortgage credit report,” which may include other details about your financial life, such as rental history or public records. These reports reveal the borrower’s credit details from multiple bureaus—TransUnion, Experian, Equifax—or all three.
In many cases, the credit score you see as a consumer—possibly through your bank or credit card company—is different from what a potential mortgage lender would see.
Improving Your Credit Score
There’s a lot that goes into determining your credit score, including your repayment history, the total balances on your accounts, how long you’ve had those accounts, and the number of times you’ve applied for credit in the last year. Improving in any of these areas can help increase your score.
- Pay down your existing debts and credit card balances
- Resolve any credit issues or collections
- Avoid opening new accounts or loans
- Pay your bills on time, every time
You should also pull your credit report and check for any inaccuracies you might see. If you find any, file a dispute with the reporting credit bureau, and include the appropriate documentation. Correcting these inaccuracies could give your score a boost.
By law, you are entitled to a free copy of your credit report from each of the three credit bureaus every year. However, as of April 20, 2020, the three major credit bureaus—Equifax, TransUnion, and Experian—increased the frequency to once per week, in a program that was set to expire after one year. It has since been extended, enabling individuals to get a free copy of their credit report weekly through 2022.
If you haven't done so already, get yours from AnnualCreditReport.com before you start shopping for a mortgage loan.