Your credit score controls many financial decisions in your life. It also controls whether you remain a renter or become a homeowner. How do you know if your score is high enough for a mortgage? What does high enough even mean? Potential homeowners often ask these questions. We discuss the answers below.
What is the Required Credit Score?
Unfortunately, there’s no magic answer. There isn’t one credit score that renders you a mortgage approval. It’s based on many factors. It’s also a subjective decision. One thing is certain, though, the higher your score, the better your chances of approval.
There are specific categories credit scores fall into:
- Excellent – 750 and above
- Good – 700-749
- Fair – 650-699
- Poor – 600-649
- Bad – Below 600
This is the general rating most lenders use. This doesn’t mean if you have a 698 credit score you instantly fall into the ‘fair’ category. It also doesn’t mean you are ineligible for conventional programs. Lenders look at the big picture, which we discuss below. For now, let’s focus on the credit scores and what you must know.
Mortgage Programs and Minimum Credit Score Requirements
Each mortgage program does have a minimum credit score. The most common programs are as follows:
- Conventional – Generally, lenders prefer credit scores above 680 for this program. Some lenders will accept lower scores. You can expect a higher interest rate as a result, though. You may have to shop around as well. Not every lender will accept lower credit scores
- FHA – According to the FHA, borrowers need only a 580 credit score for FHA financing. The do grant an exception for borrowers with a credit score as low as 500, though. These borrowers must put 10% down rather than 3.5%, though. Again, different lenders accept different credit scores. Many won’t go below 620, while others allow scores as low as 500.
- VA – The VA doesn’t have a minimum credit score for their loans. But most lenders won’t allow scores lower than 620. Again, this varies by lender and circumstance. The more compensating factors you have, the lower minimum credit score lenders require.
- USDA – The USDA requires a credit score of at least 640 for their 100% LTV loan program. Scores below 640 may secure approval, but you’ll undergo more scrutiny.
Lenders and What They Require
The above credit scores are those that the representing agency requires. Each lender can add what they call overlays. These are additional lender requirements. As long as the lender meets the minimum requirements the agency requires, they can add whatever they want. The agencies sponsoring the loan programs don’t fund the loans. The lender provides the funds. Because of this, sometimes lenders want to be a little more restrictive in their offerings.
While there are hundreds of overlays, a few of the most common include:
- Higher credits cores than programs require
- More restrictive debt ratios than programs require
- Longer wait times after filing for bankruptcy or experiencing a foreclosure
- More reserves than a program requires
The lender overlays may make up for a risky file. For example, USDA loans don’t require a down payment. The USDA has other requirements that make the files less risky. But some lenders want to tighten the reins to avoid default. They may require a higher credit score or lower debt ratio than the USDA requires.
Luckily, you can shop lender overlays. If you don’t like what one lender says, try another. There’s no harm in shopping around. In fact, we recommend it. This way you get the least restrictive loan and best deal.
How a Credit Score Affects Your Mortgage
Even if you find a lender willing to take your low credit score, it could affect other things. An approval is one thing. Your interest rate is another. This is where your credit score really affects things. Even if you have the minimum score required for a conventional loan, it doesn’t mean you’ll get a great interest rate. Lenders have what they call loan level adjustments. Basically, it’s an addition to your base interest rate. The addition makes up for the riskiness your low credit score creates.
Two borrowers with the same exact qualifications, but different credit score will likely see 2 different interest rates. Each lender differs in the amount they add to the score, though. Again, shopping around can work to your benefit. You may find a lender with a greater threshold for risk that won’t add as much to your interest rate.
Bad Credit Doesn’t Mean No Home
Many people with bad credit assume they can’t buy a home. This isn’t the case, though. There are other factors that matter. Lenders look at the big picture. In other words, they look to see how the pieces of the puzzle fit together. Here are 2 examples:
John has a 620 credit score. He has held the same job for 10 years. He has also had a pay increase each year. His debt ratio is 28/34 and he has 6 months of reserves on hand. John applies for a conventional loan and receives it despite the lower credit score. John’s compensating factors make up for the lower credit score.
Joe has a 620 credit score too. However, he has a new job. He just started it 6 months ago. Joe also has a gap in his employment history. It seems like every few months he stops working for a while. Joe’s debt ratio equals 32/40 and he has no reserves. Joe applies for a conventional loan but does not get it. His big picture is even riskier than looking at his credit score alone.
Joe might have a chance at an FHA loan. His debt ratio is in line with the FHA requirements. He may also secure a USDA loan if he buys a rural home. But, Joe must get his work history in order. He needs more stable employment so lenders can see that he isn’t a big risk.
Whether your credit score is high enough or not depends on the situation. It also depends on the lender. One lender might think it is while another might not. Don’t give up. Make sure you shop around. There are many lenders and mortgage programs out there. Even if you have to take a subprime mortgage for the time being, you can refinance out of it later. The key is getting into the home you want.
If you have the time, work on your credit score. Try to make it as high as you can. But don’t overlook your other qualifying factors. You must consider many things. Make yourself look as responsible as possible. This way you can find a loan program that works for you.