The Credit Score You Need to Buy a House
Looking to buy a home? Even if you thought you had bad credit, you might wonder if your credit score is high enough to qualify for a mortgage. Credit scores are important, but you may still be eligible for a mortgage even with less-than-stellar credit. Think of your credit score like the score in a football game. It gives a good idea of performance, but you need to watch the game (i.e., check your credit report) to get the full story. Here is what lenders are looking for in your credit history and what you can do to improve your credit score to buy a house:
It may not be the determining factor, but the third most common concern among lenders in a 2014 FICO study was a low credit score.* FICO scores range from 300 to 850. While credit score thresholds differ by loan type, FHA loans require applicants to have a minimum score of 580 to qualify for a low down payment. You can still apply with a lower credit score, though you’ll have a higher down payment and APR as a result. Once your score dips to below 500, you’re no longer eligible for any FHA mortgages. And, if you’re interested in the best interest rate possible, you’ll need a credit score of approximately 740 or higher.
The good news is that these numbers aren’t set in stone, and in recent years, lenders have become less strict about credit scores. On the flip side, this fluctuation means that credit score requirements can become stricter if there is an economic downturn.
On-time payments on your credit cards, loans and bills are your way of communicating to lenders that you’ll pay for your loan on time as well. Missing just one payment can lower your credit score, and missing several will significantly reduce your chance at a loan. Defaulting on a loan, declaring bankruptcy or foreclosing a previous home will require years of rebuilding your financial reputation before you’ll be considered for a large loan.
Age of Credit History
The second most common concern for lenders in the FICO study was “multiple recent applications for credit.” For instance, if you’re trying to go from one credit card to several within a short period of time, it might raise a red flag that you can’t afford your monthly obligations. The length your accounts have been open is also important when asking for loans. This goes back to payment history—lenders want to see evidence that you’re capable of paying off multiple credit cards and other loans on time for years.
Your debt-to-income ratio consists of two numbers comparing your debt and expenses to your income. The first number is known as your front-end ratio and is your expected housing expenses divided by your gross monthly income; the result is multiplied by 100. Your back-end ratio comes next and is calculated by adding your monthly debt expenses with your housing expenses and dividing this amount by your monthly gross income; this is then multiplied by 100. These two numbers are the lender’s way of judging your ability to manage payments and were the top concern 59 percent of lenders had in the FICO study. The lower your ratio of debt to income, the more likely you are to receive a loan. For your best shot at an affordable loan, lenders say your front-end ratio should be 28 percent or less and your back-end ratio should be 36 percent or lower.
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