A Few Points Can Make A Big Difference When Applying for a Mortgage.
If you are like most home buyers, you will need to finance your home purchase. Mortgages are loans designed specifically for that purpose, and they are available from a wide range of sources, including banks, finance companies and credit unions, as well as government-backed agencies such as Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA).
In most cases, a mortgage represents a large amount of money repaid over a long period, typically 15 to 30 years. The total cost to buy your home will include the money you put down, the amount financed, and the interest that accrues over the life of the loan.
To determine your creditworthiness (i.e. the likelihood you will repay your loan as agreed), lenders will consider a number of factors, including your income, your savings, and any outstanding debts. But the most important factor is your credit profile, which is represented — accurately or not — by your credit score.
The credit score you need to buy a home varies by the finance source as well as the other factors listed above and, at times, the state of the economy. Let’s dig a bit deeper to see how your score measures up.
The Big Score
The most popular credit-scoring models, FICO and VantageScore, assign numbers ranging from 300 to 850. In the wake of the subprime mortgage crisis that sparked the Great Recession, banks and finance companies tightened their lending guidelines to the point where applicants with scores as high as 720 were being turned down.
That is an extreme example of market forces affecting your chances of approval. In most cases, including the current market, your own score is much more important. But 720 is still a key number: In the consumer finance game, that is considered a “very good” score. With a 720-plus score and a record free of bankruptcies, foreclosures and vehicle repossessions, you are likely to be approved by most lenders and enjoy the lowest available interest rate.
The next commonly accepted credit score threshold is 660. If you are at or above this number, you will be considered a “good” credit customer, and you will likely qualify for a competitive interest rate.
If your credit score is 659 or lower, your prospects on the open market narrow. There are a number of mortgage companies set up specifically to serve credit-challenged home buyers, but they are more likely to offer unappealingly high interest rates.
Fannie Mae and Freddie Mac have set a minimum score of 620. The FHA typically qualifies buyers with credit scores as low as 580. The FHA may still be willing to extend credit if your score is less than 580, but you may need to come up with a larger down payment.
Plans B and C
Whatever your credit score, its role in the decision-making process can be diminished by other factors that work in your favor. If you can prove your score is not reflective of your ability to repay a mortgage, you may be able to work with more lenders or qualify for a lower interest rate.
Before you shop for a home loan, arm yourself with your printed credit report, bank statements, recent pay stubs, and your most recent tax return. Next, create a summary of all your assets and outstanding debts. Finally, create a worksheet that lists all your fixed monthly expenses, including rent, car payments, student loan payments and insurance premiums.
If you feel your full financial picture offers a compelling case for approval at a competitive interest rate, you can proceed with confidence. If not, you may wish to reconsider your decision to buy a home.
Unlike renting, home ownership generates a long list of expenses. That list includes closing costs, property taxes, homeowner’s insurance, maintenance and repairs — none of which can be financed.
More to the point, if you are on the very edge of qualifying for a mortgage or a competitive interest rate, you may wish to repair your credit before you buy. The “breaking points” between fair, good and excellent scores can represent tens of thousands of dollars in additional finance charges. By continuing to make all your monthly payments on time and reducing your credit-card balances and other outstanding debts, you will improve your score — and give yourself time to save for a bigger down payment or create a fund for household expenses.
Are you considering refinancing your mortgage? Read our guide to home loan refinance.