March is National Credit Education Month, making it the perfect time to understand how your credit score affects your path to home ownership. In this month’s Home Matters Blog, we explore how your credit score can impact your home buying journey, how it is calculated and what score you might need to buy your first home.
What is a Credit Score?
A credit score is a number, based on your credit history, that estimates how likely you are to repay debt. It is typically a three-digit number between 300 and 850. The larger the number, the better your credit is considered to be. Having a high credit score can help ensure you get the best mortgage terms on your home loan. On the other hand, a low score means you might not get the best mortgage terms possible, or that you might not be able to secure a mortgage loan at all.
How is Your Credit Score Calculated?
- Payment History: Have you paid your past credits on time? Payment history reflects not just whether you’ve made payments on time, but also how late any missed payments were, the amounts owed and how often late payments occurred. A consistent record of on-time payments helps build strong credit, while frequent or recent late payments can lower your score.
- Amounts Owed: Each source of credit comes with a credit limit. How much of your available credit are you using? Lenders like to see that you can responsibly use credit and pay it off, too. A general rule of thumb is to keep your credit utilization ratio below 30%.
- Length of Credit History: Credit score calculations take into account how long you’ve had your oldest and most recent credit accounts open. In general, having a longer history of credit in good standing is better for your score.
- New credit: How often have you applied for new credit? Opening multiple new credit accounts in a short time can be a red flag to lenders, especially if you’re new to credit.
- Types of credit: How many types of credit accounts do you have? Lenders prefer to see that you can handle different types of credit responsibly and reward a mix of accounts like loans and credit cards. Examples of types of credit accounts include credit cards, mortgages, home equity loans, auto loans, student loans and personal loans.
Lenders use your credit score as a part of the mortgage approval process to determine your creditworthiness when applying for a home loan.
How Your Credit Score Affects Your Mortgage Rate
Your credit score is a key factor mortgage lenders use to determine:
- Mortgage approval: Higher scores increase your chances of getting approved for a mortgage.
- Interest rates: Lower scores often mean higher interest rates, which can cost you thousands over the life of a loan.
- Loan terms: Some home loan programs have minimum credit score requirements you must meet to qualify.
What Credit Score Do You Need to Buy a House?
- 300-579: Very high-risk borrower. Unlikely to qualify for a home loan, making it difficult to secure financing for home ownership.
- 580-639: Possible approval, but expect high interest rates and fees, especially for conventional loans.
- 640-699: Qualified for a home loan, but not the best mortgage rates available.
- 700-749: Strong borrower with access to good interest rates and more home loan options.
- 750-850: Excellent credit! You’ll qualify for the best interest rates and loan terms.
How Credit Scores Affect Your Mortgage Loan Beyond Just Approval
Your credit score doesn’t just determine if you get a mortgage—it impacts:
- Down payment requirements: Borrowers with lower scores may be required to make a larger down payment.
- Private Mortgage Insurance (PMI): If your credit score is low, lenders may require PMI, which increases your monthly payment and overall loan cost.
- Loan limits: Certain loan types have specific borrowing limits that may be affected by your credit score.
Your credit score plays a crucial role in your home buying journey. A higher credit score not only improves your chances of getting approved for a mortgage but also helps you qualify for better loan terms, lower interest rates and reduced upfront costs. Understanding how credit scores affect mortgage rates and approval allows you to make smarter financial decisions before buying a home.
Ready to take control of your credit? Click here for tips on how to improve your score and get closer to home ownership!
