Credit scores are crucial if you are in the process of buying a new home. Not only does your FICO score determine if you can qualify for a loan in the first place, but it will also have a substantial impact on your mortgage terms. However, you do not need to have an exemplary credit score to get a mortgage, and in some cases, your score can even be in the 500s. In this article, we cover the mortgage types that you can qualify for with varying levels of credit and also show how you can improve your credit score and get ready for a mortgage.
Loans options by credit score
- 300 – 499: With this low of a credit score, you are unlikely to get a mortgage unless someone, a friend or family member, is willing to help out.
- 500-620: If you have a credit score in this range, your best option for a home loan is one insured by the Federal Housing Administration (FHA). Designed to help consumers get into their first homes, FHA loans are issued by the same kinds of lenders that provide conventional loans, including banks, credit unions and mortgage brokers, but are subject to strict FHA guidelines to prevent defaults. Importantly, if you have a credit score of 500 to 579, you must be prepared to make a down payment of at least 10% to qualify.
- 620 – 699: In this credit range, you may qualify for government-backed loans, including home loans issued by the U.S. Department of Agriculture (USDA) and by the United States Department of Veterans Affairs (VA) for active-duty military, veterans and eligible spouses. Moreover, qualified borrowers with a credit score of 620 or higher qualify for conventional loans, which are not backed by a government agency like the FHA, the VA or the Agriculture Department.
- 700 – 739: Home buyers with credit scores in this range will qualify for conventional loans with even better interest rates. You may also begin to find lenders who will consider you for higher value homes requiring “jumbo” mortgages. A jumbo mortgage is a mortgage loan for an amount that exceeds the conforming loan limit and is reserved for those with excellent credit.
- 740 or higher: With a FICO credit score of 740 or higher, you are likely to be approved for the most favorable of interest rates, especially for conforming (non-jumbo) loans. At this credit range you will also be eligible to earn a lower cost for private mortgage insurance (PMI), which is required if you make a down payment of less than 20%.
How to build up your credit score and secure a better mortgage
No matter what type of mortgage you are seeking, it is always in your best interest to apply with the highest credit score you can. However, meeting the minimum credit score requirement is only the beginning. It is important to remember that lenders also use your credit score to determine your mortgage terms, including both the interest rates and the fees associated with the loan. The higher your score, the better your borrowing terms will be and the less you will have to pay over the life of the loan.
If your credit score doesn’t allow you to get the best deals on a mortgage, it might make sense to put a pause on buying, and rent for a while, using the time to improve your credit score. Here’s how:
- Pay your bills on time: Payment history is the biggest component in determining credit score. As long as you stay on top of your payments, your credit score will rise.
- Lower your credit utilization rate: To raise your credit score, you must keep your credit card balances low. The credit utilization rate measures the amount of your credit limit that is being used and accounts for 30% of your credit score, making it the second largest component of your credit score. Most experts recommend that you use 10-30% of the limit on any credit card, to help build up your credit score. and much lower is much better.
- Keep credit cards open: Unless your credit card is charging you an unbearable annual fee or your credit card is new, it is best to keep it open. Closing unused credit cards will result in your credit utilization rate rising, resulting in a damaged credit score.
- Look to transfer or refinance existing debts: Being unable to pay off debts due to high-interest payments, can have large negative impacts on your credit score. However, by refinancing your loans you can have lower monthly payments helping you earn a stronger credit score. Many mortgage lenders allow borrowers to refinance their loans at a lower interest rate after their seasoning period or the time where you can not refinance a loan. Ask your mortgage lender when this period ends and shop around for the interest that is best for you. As always, make sure to check any and all terms, as depending on the additional refinancing costs and the length of the loan, refinancing can have adverse consequences.
Your credit score plays an important role in determining your ability to get a mortgage, as well as the terms of this loan. While it is possible to get a mortgage with credit scores in the 500s, your options will only improve as your credit score rises. If your credit score is lower than you would like, and you are not receiving mortgage options that suit your needs, you might be better off delaying your entry into the homebuying process, and opting to raise your credit instead.