What Credit Score Do You Need to Buy a Home?

The minimum credit score requirement for the different types of loans available.

If you want to buy a home and you aren’t paying 100% cash, any competent residential mortgage banker will confirm that your credit score is going to matter. First, it will help determine if you’re likely to qualify for any mortgage and second, it will help establish what interest rate you may be charged.

So, what is a credit score? How is it determined? And how can you fix a bad one? Read on.

What is a Credit Score?

A credit score is a grade based on your credit history—how many entities have extended credit to you, how much credit they have extended and how diligently you’ve paid your debts. There are bureaus that compile and report on credit history: Experian, TransUnion and Equifax. These credit bureaus gather and analyze data to arrive at a FICO score—a measure of consumer credit risk. Because creditors generally don’t report information to all bureaus, you are likely end up with three different FICO scores. Mortgage lenders typically use the middle one. One of the most reliable sources to review your FICO score is myFICO.com.

How is a Credit Score Compiled?

Credit scores can range from 300 to 850 points, but the rating is not just based on how quickly you pay off your debts. While payment history does account for 35% of the score, the total amount owed is important (30%), because the larger your debt, the higher the risk. The length of time you’ve used credit is taken into account (15%)—the longer, the better—and also how much “new” credit you’ve recently accessed (10%). Finally, your overall mix of credit is worth 10%. A diverse mix may be comprised of student loans, car loans and unsecured revolving debt (credit cards).

What Credit Score is Needed to Qualify for a Mortgage?

Since the Dodd-Frank Wall Street reform was signed into law in 2010, it has become more difficult for people with poor credit to qualify for mortgage loans. However, different types of loans have different requirements. While it’s possible (but difficult) to get an FHA loan with a credit score as low as 500, the down payment needed is higher (10%). With a score of 580 or more, you can qualify for an FHA loan with as little as a 3.5% down payment and the approval is more likely. Veteran’s (VA) loans and conventional loans from mortgage services companies like Ark Mortgage typically require a score of 620 or higher.

The higher the credit score, the more likely a borrower will qualify for a lower interest rate with mortgage lending firms. A score of 760 (or higher) traditionally receives the lowest rates. Additionally, lenders may also require that there be no late or delinquent payments for the past 12 months, a low debt-to-income ratio (amount you owe compared to the amount you earn) and a solid employment history (2 years minimum).  Factors that reduce the lender’s risk and might compensate for lower credit scores include a larger down payment, high income, substantial savings and a long employment history with your current employer.

What Can You do to Improve Your Credit Rating?

If your credit isn’t as high as it could be, the best thing to do is start the reparation process before starting to shop for a home. Here are some steps you can follow:

1. Obtain your credit report and scan for mistakes. You are entitled to a free annual report from each of the three credit bureaus. Just visit AnnualCreditReport.com. Recent studies show that 20% of consumers find errors on at least one of their three reports and that four out of five people who filed a dispute were successful in modifying their reports. Some even saw a change in their credit score by simply correcting a reporting error.
2. Get into the habit of paying off credit card balances quickly.
3. Keep your revolving credit utilization ratio low. This is the ratio between your total credit and the amount you owe. Lenders like to see your debt remain at 30% or less of your available credit.
4. Refrain from opening any new credit accounts. It’s counter-intuitive but each credit request lowers your credit utilization ratio. Applying for several credit accounts in a short period of time is a red flag for credit reporting bureaus and can reduce your FICO score by 10%. One exception is when you are shopping for a car, mortgage or student loan, in which all applications opened within 45 days count as one application.
5. If any of your creditors have turned your debts over to a collection agency, contact the collection agency directly and ask them to do a “Pay for Delete” meaning that you agree to pay the balance and they agree to remove the account from your credit report. This won’t improve your credit but might be expected by your lender.
6. If you have a family member or close friend with good credit, ask them to add you as an authorized user to their credit card account. The credit history of that account will be added to your credit report and you can add points to your FICO score. This can be especially important if you currently have no credit history.
7. Don’t close accounts to temporarily raise your credit score. This will impact your credit utilization ratio and can have the opposite effect of what you intended.

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