Key Takeaways
- Credit scores range from 300-850 and predict mortgage payment likelihood.
- FHA loans accept scores as low as 500, conventional loans need 620.
- Higher credit scores may result in lower mortgage interest rates.
- Payment history and credit utilization are the biggest score factors.
Article Summary
A credit score represents the probability that a home buyer will make on-time payments to their mortgage lender for the next 90 days.
Credit Score: Explained in Plain English
In mortgage lending, credit scores are a probability statistic and objective measure of a home buyer's risk to a lender. Higher credit scores correlate to lower lending risk.
The most common mortgage credit scoring model is the FICO score, which was named for the Fair Isaac Corporation. FICO developed its credit model in 1956 and continues to fine-tune its predictive algorithm today.
FICO credit scores are based on five weighted categories that combine to generate a rating between 300 and 850, with 850 being the highest credit score possible. Mortgage applicants with higher credit scores are more likely to make their mortgage payments over the next 90 days, which reduces their risk of mortgage default.
As a result, having a high credit score is typically linked to getting a lower mortgage rate.
FICO Scores and Credit Ratings
| FICO Score | Credit Rating |
|---|---|
| 740 FICO or higher | Excellent credit |
| 660-739 FICO | Above-average credit |
| 620-659 FICO | Average credit |
| 580-619 FICO | Below-average credit |
| 579 FICO or lower | Poor credit |
The Components of a Credit Score
The 5 Components of a Credit Score
| Credit Score Component | Percentage of Total Score |
|---|---|
| Payment history | 35% of the credit score |
| Amounts owed / maxed-out percentage | 30% of the credit score |
| Experience managing credit (in years) | 15% of the credit score |
| Types of credit extended | 10% of the credit score |
| Recent new credit extensions | 10% of the credit score |
A mortgage credit score predicts a home buyer's next 90 days, relying on models that prove recent events affect future performance.
For example, a home buyer who missed a payment this month would likely miss a payment again next month, damaging their credit score. However, a missed payment two years ago is proved to have no bearing on the next 90 days and wouldn't affect their score by even one point.
The credit score algorithm forgives, and credit scores can be rebuilt.
Credit Score Requirements and Mortgage Options
Minimum FICO Scores for Popular First-Time Home Buyer Mortgages
| Mortgage Type | Minimum FICO Score |
|---|---|
| Conventional mortgage | 620 minimum FICO |
| FHA mortgage | 580 minimum FICO |
| VA mortgage | 620 minimum FICO |
| USDA mortgage | 640 minimum FICO |
A home buyer can get approved for a mortgage with a 500 FICO score or higher. Low-downpayment mortgage options are available for buyers with FICO scores of 580 or higher.
Lender Overlays: When Requirements Are Higher Than Minimums
Sometimes, mortgage companies establish their own higher minimum credit score requirements to reduce their lending risk. These underwriting choices are called lender overlays.
For example, while an FHA-backed mortgage technically permits a 500 FICO to be approved, lenders may require 580 FICO or higher. Lenders may also raise their conventional mortgages minimum FICO up to 660.
Lender overlays vary by lender.
Adding a Co-borrower to Meet Credit Requirements
When your credit score is below lender standards, you can shop for another lender, or consider adding a co-borrower with stronger credit to your application. Co-borrowers appear on the loan focuments and share responsibility for the home's mortgage payment.
Lenders typically use the lower of the two credit scores when evaluating co-borrower applications, but the stronger borrower's income and assets can help offset credit concerns.
Co-borrowers don't need to live in the home or be related to the primary borrower. Parents, adult children, siblings, or even friends may co-sign mortgages to help home buyers qualify for better rates and terms.
Credit Score: A Real World Example
Imagine a first-time home buyer who gets pre-approved for a mortgage six months before planning to buy a home.
As part of the mortgage pre-approval, the buyer learns their credit score is 610, which is high enough to get approved for an FHA mortgage, but not high enough for the potentially lower mortgage rates that a conventional mortgage can offer. So, the buyer begins taking steps to make their credit score higher.
First, they keep their credit cards current and set digital reminders to pay every bill on time. Then, they use free cash to pay down smaller credit cards and shift around some balances. Lastly, they stop applying for new cards and then sign up for a credit building service.
Within 6 months, the home buyer's credit score climbs sharply, and the buyer qualifies for FHA, conventional, VA, and USDA mortgages, with new affordability options and lower monthly payments.
Common Questions About Credit Scores
Frequently asked questions about credit scores and how they affect mortgage approval.
How is a credit score calculated?
Credit scores are calculated using the information in your credit report, including your payment history to your creditors, overall credit utilization on your accounts, length of credit history in years, ages of your credit accounts, and the types of credit you use.
Can I get a mortgage with a low credit score?
Yes, home buyers get mortgages with low credit scores all the time. However, with a low credit score, interest rates might be slightly less favorable.
How can I improve my credit score quickly?
To improve your credit score quickly, check your credit report for errors, bring your delinquent bills current, and avoid opening new credit lines. Reputable credit-building services can help, too.
What factors will negatively impact my credit score?
Certain credit events will lower your credit score quickly, such as missing payments to creditors, spending near your credit limits, and applying for multiple new credit lines in a short period.
Is it possible for errors to appear on my credit report?
Yes, errors can appear on your credit report. These might include incorrect personal information, accounts that don't belong to you, or inaccurate account statuses. Regularly reviewing your credit report will help you identify and dispute any errors.
