The Home Buying Institute offers hundreds of mortgage and home-buying articles, with new lessons coming online every day. But one topic reigns supreme when it comes to traffic and readership. It has to do with home buyer credit scores. Specifically, it attempts to answer the question: What score is needed to buy a house?
Clearly, home buyers are deeply concerned about their credit scores. And they should be. These three-digit numbers carry a lot of weight when it comes to mortgage approval. Some argue they carry too much weight, disqualifying home buyers and borrowers who are otherwise well-qualified for a loan.
Credit scores also confuse the heck out of home buyers, judging by the emails we receive. This is not surprising, given the needlessly complicated nature of the credit-reporting and scoring industry. In some cases, home buyers who take the initiative to research credit scores end up even more confused than when they began. (Do a Google search for the “different types of credit scores,” and see if you can make sense of it.)
Home buyers need to understand a few basic concepts about credit scores. But there’s also a lot they don’t need to know. When it comes to understanding this subject, less is more. There’s no need to get lost in the weeds.
What Home Buyers Should Know About Credit Scores
In the spirit of home buyer education (and sanity), we’ve compiled a list of “need-to-know” factoids about credit scores. So without further ado, here are 17 things every home buyer should know about credit scores.
- Your credit score is derived from information found within your credit report, which contains financial data going back seven to ten years. Your reports show how you have borrowed and repaid money in the past. Your scores are simply a numerical representation of this data.
- Home buyer credit scores are influenced by five key factors: (1) your payment history on loans, cards, etc.; (2) the total amount you currently owe on these various accounts; (3) the length of your credit history; (4) new credit accounts opened recently; and (5) the different types of credit you use.
- There are different types of consumer credit scores. Home buyers only need to be concerned with two, and possibly only one. Most mortgage lenders use some version of the FICO score or the VantageScore. According to MyFICO.com, the official website for the FICO scoring system: “FICO scores are the credit scores most lenders use to determine your credit risk and the interest rate you will be charged.”
- The FICO and VantageScore ranges both go from 300 to 850 (the old VantageScore range went from 501 – 990, but has been phased out). In both scoring models, a higher number is better. When someone talks about having “excellent credit,” they mean they have a high score relative to other consumers.
- Mortgage lenders use home buyer credit scores for risk-assessment purposes. They use them to measure the level of risk associated with each individual borrower, and to determine whether or not the borrower is qualified for a loan. They have other ways to measure risk, such as debt-to-income ratios. But the credit score is one of the leading risk-assessment tools in the lending industry.
- Home buyers with lower credit scores are statistically more likely to default on their loans. Thus, they present a higher risk to lenders.
- Home buyers with higher scores are generally viewed as low-risk borrowers. The higher number indicates that they have paid most or all of their bills on time in the past. In other words, they have borrowed and repaid money responsibly.
- Home buyers with lower credit scores generally have a harder time getting approved for mortgages. They usually end up paying a lot more interest as well, if and when they do get approved for a loan.
- Credit score requirements are not standardized across the board. They vary from one lender to the next. Some lenders set the bar higher than others, while some are willing to work with home buyers with lower scores. It all comes down to how the lender measures and defines risk, and how comfortable they are with risky borrowers.
- Our survey-based research shows that most mortgage lenders set the bar somewhere between 620 and 640 on the FICO scoring scale. As a result, home buyers with credit scores below 620 may have a harder time qualifying for a loan in the current market.
- Borrowers with scores below 620 may find it easier to qualify for a government-insured FHA home loan, compared to a conventional or “regular” mortgage. Generally speaking, FHA loans are easier to obtain than the stricter conventional mortgages.
- Late payments can cause serious damage to a home buyer’s credit score. In this context, we are talking about late or missed payments on cards and loans. According to Barry Paperno, community director for Credit.com: “a recent late payment can cause as much as a 90 – 110 point drop on a FICO score of 780 or higher.” A pattern of late payments and delinquencies can lower a score by 200 points or more.
- Over-relying on credit cards can also lower a home buyer’s overall score. In industry jargon, this is referred to as the utilization ratio. It measures how much credit you are using (or “utilizing”) in relation to your limits. For instance, when a person maxes out a credit card, he or she is using 100% of the available limit. The utilization ratio is another type of risk indicator. People with higher ratios represent a higher risk to lenders. As a result, a high utilization ratio can lower a person’s overall credit score.
- Home buyers can improve their scores by paying all of their bills on time, and by reducing their credit card balances. These are the two most effective methods, according to industry experts.
- By law, consumer credit reports are free. Consumers are entitled to one free report per calendar year, from all three of the reporting agencies that compile them (TransUnion, Equifax and Experian). Scores, on the other hand, are a different matter. In most cases, consumers have to purchase their scores. You can buy them directly from the three reporting companies for about $20 each.
- Many companies offer “free” scores to consumers who sign up for some kind of credit-monitoring or identity-theft-protection service. According to Consumer Reports, “do-it-yourself safeguards are just as effective as paid [ID theft protection] services.”
- There’s a chance the score you buy may be different from the one lenders use when considering you for a mortgage loan. But they are similar enough to make it a worthwhile purchase. We encourage home buyers to check their credit before applying for a mortgage loan. It gives you a sense of where you stand, in terms of your qualifications and your negotiating ability.
Credit scores are not the only factor lenders use to approve borrowers. Debt ratios, income stability, cash reserves and down payments are equally important. But these three-digit numbers are one of the most important factors when it comes to loan approval and interest rates.
Statistics show that borrowers with higher scores have an easier time getting approved for home loans. That’s a strong incentive on its own. But there are other benefits. These borrowers are also better positioned to negotiate a lower mortgage rate from the lender.
In contrast, home buyers with lower scores have a tough time getting approved for financing. And when they do get approved, they end up paying a lot more money in interest. This concept is known as risk-based pricing. Riskier borrowers encounter higher borrowing costs. A higher interest rate could add up to thousands of dollars over the life of the loan. So it literally pays to have good credit.