The minimum credit score seems to hang over your head when you think about buying a home. What do lenders require in order to qualify you for a loan? Is your credit good enough? Even if you know your actual score, you might still wonder what lenders will accept you as a “good risk.” Even if you are not necessarily a good risk, some lenders might still approve you for a mortgage as there are many programs available. Understanding how the scores work and what lenders look for will help you determine your eligibility for a home loan.
What Makes up a Credit Score?
The first thing you need to understand is what makes up a credit score. It is more than just making your payments on time. 5 unique aspects factor into your score as well as your history. Lenders use every aspect of your score to determine your risk level. The five areas include:
- Timeliness of your payments – Any payments more than 30 days late count against you and the increments go up from there. For example, a payment which you do not make for 2 months counts as a 60-day late, which is worse than a 30-day late payment.
- Credit usage – The amount of the credit you used up compared to your available credit. The lower this percentage is, the higher your credit score.
- How long you have each account – The longer you hold an account, the better it affects your credit score. New credit typically harms your score because there is no history to use to determine your risk level.
- Brand new credit – If you have a large amount of brand new credit opened, it can damage your score.
- Diversification of accounts – The more diversified your accounts, the better your credit score reacts. For example, a person with all revolving accounts will get hit harder than a person with one revolving account, one installment loan and one mortgage loan.
To keep things in perspective, the timeliness of your payments and your credit usage affect your credit score the greatest as they are 35% and 30% of your score. The length of time you held each account makes up 15% of the score and the last two factors each make up 10% of your score.
Minimum Credit Score to Obtain a Mortgage
Now that you know what makes up a credit score, you probably want to know the lowest score you can have to qualify for a mortgage. The answer is not quite as simple, though. Every program and every lender within a program has their own requirements.
Conventional loans have the highest credit score requirements. They generally require borrowers to have “excellent” or “good” credit in order to qualify. This means a score of at least 690 in most cases. Some conventional lenders allow scores slightly lower if the borrower has compensating factors, such as a low LTV, large amount of assets, or a low debt ratio. The combination of your credit history and the other factors which make up your loan give the lender a complete picture of the type of risk you pose. Does this mean if you have a score of 680 you will not get conventional financing? The answer really depends on the lender you use and how much of a loan you need. If you can prove you wish to purchase a home well within your means and you do not have a very blemished credit history (not just the score), many lenders will entertain the idea.
FHA loans offer a little more leeway with credit score requirements. In fact, you can have a score as low as 580 and still have the ability to put down just 3.5%. The FHA also allows lenders to provide loans for people with scores as low as 500 as long as they put down 10% on the home. Again, this does not mean every lender will provide a loan with a score as low as 500 – it is what the FHA allows, not requires. FHA lenders often look at compensating factors as well and take the whole financial picture to determine the level of risk you pose to them.
Veterans who served at least 90 days during wartime or 180 days during peacetime may be eligible for VA financing. This government-backed loan is similar to FHA loans, but many lenders require a credit score of at least 620 in order to qualify. The difference with VA loans compared to FHA loans or any other program is the VA’s focus on the history rather than the score. They might allow someone with a lower score to qualify for a program if they show good recent credit history. This program is very forgiving and awards veterans who revamped their financial priorities and started making payments on time, rather than focusing strictly on the score.
As you can probably guess, subprime loans are the offering for those with credit scores below the conventional and FHA requirements. Sometimes even people with higher scores opt for subprime loans though, especially self-employed borrowers who cannot verify their income in the standard way. Subprime loans do not have a set minimum credit score since each lender makes their own rules. In general, lenders prefer scores over 620 because experts consider anything lower “bad credit.”
The main thing to remember is to not focus strictly on your credit score. Look at your entire financial picture to see how a lender will look at you. You could have a high score, but have no assets, a questionable employment history and high debt ratio. This would not qualify you for a loan. You need to present an attractive financial picture in all aspects in order to qualify. Of course, a high credit score certainly helps you get your foot in the door, but if the other factors do not fall not place, you could have more difficulty securing a mortgage than you thought.